Tag Archives: Asset allocation

01.07.25
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Will You Do Nothing?

By: Russ Kamp, CEO, Ryan ALM, Inc.

I recently read an article by Cliff Asness of AQR fame, titled “2035: An Allocator Looks Back over the Last 10 Years”. It was written from the perspective that performance for world markets was poor and his “fund’s” performance abysmal during that 10-year timeframe. His take-away: we can always learn from our mistakes, but do we? He cited some examples of where he and his team might have made “mistakes”, including:

Public equity – “It turns out that investing in U.S. equities at a CAPE in the high 30s yet again turned out to be a disappointing exercise”.

Bonds – “Inflation proved inertial” running at 3-4% for the decade producing lower real returns relative to the long-term averages.

International equities – “After being left for dead by so many U.S. investors, the global stock market did better with non-U.S. stocks actually outperforming”.

Private equity – “It turned out that levered equities are still equities even if you only occasionally tell your investors their prices”. When everyone is engaged in pursuing the same kind of investment there is a cost.

Private credit – “The final blow was when it turned out that private credit, the new darling of 2025, was just akin to really high fee public credit” Have we learned nothing from our prior CDO debacle?

Crypto – “We had thought it quite silly that just leaving computers running for a really long time created something of value”. “But when Bitcoin hit $100k we realized that we missed out on the next BIG THING” (my emphasis) “Today, 10 after our first allocation and 9 years after we doubled up, Bitcoin is at about $10,000.”

Asness also commented on active management, liquid alts, and hedge funds. His conclusion was that “the only upside of tough times is we can learn from them. Here is to a better 2035-2045”

Fortunately, you reside in the year 2025, a year in which U.S. equities are incredibly expensive, U.S. inflation may not be tamed, U.S. bonds will likely underperform as interest rates rise, the incredible push into both private equity and credit will overwhelm future returns, and let’s not discuss cryptos, which I still don’t get. Question: Are you going to maintain the status quo, or will you act to reduce these risks NOW before you are writing your own 10 year look back on a devastating market environment that has set your fund back decades?

As we preach at Ryan ALM, Inc., the primary objective when managing a DB pension plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. Continuing to invest today in many segments of our capital markets don’t meet the standard of low cost or of a prudent nature. Now is the time to act! It really doesn’t necessitate being a rocket scientist. Valuations matter, liquidity is critical, high costs erode returns, and no market outperforms always! Take risk off the table, buy time for the growth assets to wade through the next 10-years of choppy markets, and SECURE the promised benefits through a cash flow matching (CFM) strategy that ensures (barring defaults) that the promised benefits will be paid when due.

Thanks, Cliff, for an excellent article!

12.30.24
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ARPA Update as of December 27, 2024

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

We, at Ryan ALM, Inc., wish for you a happy, healthy, and prosperous New Year in 2025. May the markets continue to treat you well. However, nothing grows to the heavens, so it may be wise to alter one’s asset allocation and reduce risk as the year begins given inflated valuations, particularly for large cap US equities.

Regarding ARPA and the PBGC’s on-going effort implementing this critical legislation, there was a pause in activity during the last week. Good for them, as 2024 has been an incredibly busy and successful year. Regarding last week, the PBGC’s eFiling portal remains temporarily closed, so there were no new applications filed. There also weren’t any applications denied, withdrawn, or approved. Finally, there were no repayments made by funds that had received excess SFA.

To recap 2024, the PBGC approved 36 applications, awarding more than $16.2 billion in SFA grants that went to support the promised benefits for 458,446 plan participants. WOW! As the chart below highlights, only 15 of the 87 Priority Group members have yet to have the applications for SFA approved. Three of those applications are currently under review. Of the 115 funds seeking support that weren’t initially identified as a Priority Group member, 64 pension plans have participated to some extent in this program with 33 of those applications approved.

US Treasury note and bond yields (longer maturities) have risen sharply in the last few months. They are at levels not witnessed since early this year. As a result, they are providing plan sponsors with a wonderful opportunity to reduce risk without giving up potentially higher returns. We’d be happy to provide a free analysis on what could be achieved within your plan. Don’t hesitate to reach out to us.

Again, Happy New Year!

12.23.24
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Is Now The Time To Act?

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

Equity market participants were recently reminded of the fact that markets can fall, and unfortunately they usually don’t decline with any kind of notice. The impetus behind the markets’ most recent challenging day was the Fed’s relatively tame forecast for likely interest rate moves in 2025. There is no question in my mind that the nearly 4-decade decline in rates from lofty heights achieved in the early ’80s, when the Fed Funds Rate eclipsed 20%, to the covid-fueled bottom reached in early 2020, when the yield on the 10-year Treasury Note was at 0.5%, made bond returns a lot stronger than anyone’s forecast.

It certainly seemed that the US Federal Reserve provided the security blanket any time there was a wobble in the markets. This action allowed “investors” to keep their collective foot on the gas with little fear. Sure, there were major corrections during that lengthy period, but the Fed was always there to lend a hand and a ton of stimulus that propped up the economy and markets, and ultimately the investment community. As we saw in 2022, the Fed had run out of dry powder and ultimately had to raise US interest rates to stem a vicious inflationary spike. Rates rose rather dramatically, and the result was an equity market, as measured by the S&P 500, that declined 18% for the calendar year. Bonds faired only marginally better as rising rates impacted bond principals creating a collective -12.1% return for the BB Aggregate Index.

As we enter 2025, do we once again have a situation in which the Fed’s ability to reduce rates has been curtailed due to a stronger economy than anticipated? Will the continued strength and massive government stimulus drive inflation and rates higher? According to a blog post from Apollo’c CIO, here are his list of the potential risks and the probabilities:

Risks to global markets in 2025

Interesting that he feels, like we do at Ryan ALM, Inc., that the economy is likely to be stronger than most suspect (#6) leading to higher inflation, rising rates (#7), and a 10-year Treasury Note yield in excess of 5% (#8). That yield is currently at 4.6% (as of 3:06 pm).

For those that might be skeptical, the Atlanta Fed’s GDPNow model is currently forecasting GDP growth for Q4’24 at 3.1% annualized. They have done a wonderful job forecasting quarterly growth rates. Their forecasts have consistently been above the “street’s” and as a result, much more accurate.

In addition, despite the third rate cut by the Federal Reserve at the most recent FOMC meeting of their benchmark Fed Funds Rate (-1.0% since the easing began), interest rates on longer dated maturities have risen quite significantly, as reflected below.

Rising US rates, stronger growth, and greater inflation may just be the formula for a significant contraction in equity valuations, especially given the current level. Be proactive. Reduce risk. Secure the promised benefits. Under no circumstance should you just let your “winnings” ride.

12.18.24
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P&I: Asset Owner CIOs See Uncertainty in 2025

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

P&I is out with a story today about asset owner CIOs “forecasting” uncertainty for 2025. The capital markets are always uncertain. It only takes a “surprise” to disrupt even the most obvious trend. Given a new regime in Washington, stubborn inflation, geopolitical risks throughout the globe, and equity valuations that are stretched (that’s putting it mildly), CIOs have reason to be uncertain, especially over a short timeframe, such as a calendar year or two.

The lack of certainty can be destabilizing to individuals and investment strategies. I covered the psychology of uncertainty in a post earlier this year. Here were a few highlights:

  • When facing ongoing uncertainty, our bodies stay at a high level of physiological arousal, exerting considerable wear and tear.
  • Uncertainty exerts a strong pull on our thoughts and inhibits our ability to act, leaving us in a suspended waiting game.
  • We can manage uncertainty by figuring out what we can control, distracting ourselves from negative thoughts, and reaching out to others.

The last point is particularly important. We can manage “uncertainty” by figuring out what we can control. As a plan sponsor, we can utilize an investment strategy (cash flow matching or CFM) that creates certainty for the portion of the portfolio that uses CFM. In the following post, I question the significant use of equity and equity-like product in public pension systems that are accompanied by tremendous annual volatility. Again, this produces great uncertainty.

Adopting the use of greater fixed income exposure also doesn’t ensure less uncertainty, as changes in US interest rates can play havoc on fixed income strategies. ONLY with a CFM strategy do you bring certainty of cash flows (absent any defaults) to the management of pension plans. Traditional fixed income strategies benefited from a nearly 4-decade move down in rates, but there is currently great uncertainty as to the future direction of inflation and as a result, rates. With CFM one knows what the performance will look like a decade from now. With a fixed income strategy focused on a generic index, such as the BB Aggregate, one has no idea how that portfolio will perform 10 or more years from now.

Lastly, there is no reason to live with the uncertainty that many CIOs currently foresee. I wrote a piece just recently on achieving “peace of mind“. Uncertainty won’t help you in your quest for a good night’s sleep, but achieving peace of mind is very much achievable once you adopt a CFM strategy and secure the promised benefits (or grants) for some period of time. Call us. We want to remove as much uncertainty from your professional life as possible.

11.18.24
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It Doesn’t Have to be This Way

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

The Financial Times (FT) recently published an article highlighting the struggles of Ivy League schools trying to manage liquidity in the face of an extended downturn in the performance of private markets. Collectively, this august group of institutions continues to underperform the average return for higher education endowments of 10.3% for fiscal year 2024, with only 6 of 8 universities outperforming. This follows an even more challenging fiscal 2023 in which all 8 universities failed to top that year’s 6.8% average return. This difficult period in which distributions have dried up considerably, is forcing some, including Princeton, to issue bonds in order to support the operations of the schools. Haven’t we seen this story play out before?

Despite the troubles, there seems to be this reluctance to alter a strategy first adopted nearly four decades ago when Yale began to invest heavily in these strategies. In the article, Roger Vincent, former head of private equity at Cornell University said, “Everybody still believes in having as big an allocation to private equity as possible.” Really? Why? No asset class will always outperform. The problem with private equity at this time is the fact that too much money has chased to few quality deals driving up the costs of acquisition and lowering future returns. In the process, managers have become reluctant to reduce valuations in order to sell these portfolio companies which has crushed liquidity.

As I’ve written on many occasions, assets shouldn’t be lumped into one bucket focused on return either to meet benefit payments, or in this case, a spending policy. There should be two buckets – liquidity and growth. If the Ivies had structured their portfolios with this design in mind, they would have had sufficient liquidity when needed and issuing bonds wouldn’t have been necessary. Endowments and foundations would be well-served to adopt this structure. Liquidity can be managed through a cash flow matching (CFM) process, which will ensure (barring any defaults) that the cash will be on hand monthly, quarterly, and/or annually depending on the needs of the organization.

I’ve witnessed too many times throughout my 40+ year career investment ideas that got overwhelmed by cash flows. We’ve had booms and busts in real estate, equities (Dot Com era), quantitatively managed equities, gold/commodities, emerging markets, Japan, hedge funds, and on and on and… Why would “investors” believe that private equity would be immune to such action? Again, if an investment is deemed to be all weather, money will naturally flow to that “opportunity” thus reducing future prospects. One way to minimize the short-term impact of these cycles is to build in a liquidity strategy that bridges these troubled times.

10.31.24
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Pension ROA – Trick or Treat?

By: Ronald J. Ryan, CFA, CEO, Ryan ALM, Inc.

Ron brings to you today a Halloween Special titled, Pension ROA – Trick or Treat? In this research piece, Ron explores how the return on asset assumption (ROA) is calculated and some of the misconceptions associated with targeting this return as the primary objective of pension management. One of those misunderstandings has to do with the expectation for each asset class used in the plan. An asset class, such as fixed income, is only asked to earn the ROA assigned to It by using their index benchmark as the target return proxy. They are NOT required to earn the total pension fund ROA assumption (@ 6.75% to 7% today). This is an important fact to remember in asset allocation.

As always, we encourage your comments and questions. Please don’t hesitate to reach out to us. Have a wonderful Halloween with your family and friends.

10.28.24
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3% Return for the Decade? It Isn’t Far-fetched!

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

This blog is a follow up to a post that I published last week. In that post I cited a recent analysis by Goldman Sach’s forecasting a 3% 10-year return. I concluded the blog with the following: “I wouldn’t worry about the 5% fixed income yield-to-worst (YTW) securing my pension liabilities. Instead, I’d worry about all the “growth” assets not used to secure the promises, as they will likely be struggling to even match the YTW on a CFM corporate bond portfolio.”

How likely is it that Goldman and other financial institutions are “right” in forecasting such a meager return for the next decade? I’m sure that plan sponsors and their advisors are pondering the same question. Well, here is more insight into how one forecasts long-term equity returns (not necessarily Goldman’s forecasting technique) and how one might arrive at such a low equity return (S&P 500 as the proxy) that, if realized, would likely crush pension funding.

Inputs necessary to forecast the future return for the S&P 500 are the current S&P EPS ($255), future expected EPS growth (5.5%) and an assumed P/E multiple in 10 years. Finally, add in the dividend yield (1.3%) and you have your expected annualized return.

Charles DuBois, my former Invesco research colleague, provided me with his thoughts on the following inputs. He believes that nominal earnings growth will be roughly 5.5% during the next decade, reflecting 4% nominal GDP growth coupled with a small boost from increasing federal deficits as a share of GDP and a boost for net share buybacks (1.5% in total). 

Right now, earnings per share for the S&P 500 are forecasted to be about $255 in 2024. If earnings grow by the 5.5%/per annum described above, in 10 years earnings for the S&P 500 will be $428 per share.

The S&P is currently trading at 5,834, which is 22.9X (high by any measure) the current EPS. Let’s assume a more normal, but still historically high, multiple of 18X in 10 years. That gets you to an S&P 500 level of 7,704 or a 2.8% annual rate of gain over the next 10 years.  Add in a 1.3% dividend yield gets you to 4.1%. Not Goldman’s 3%, but close. It is still much lower than the long-term average for the market or the average ROA for most public and multiemployer pension plans.

If one were to assume a 15X P/E multiple in 10 years, the return to the S&P 500 is 0.64%/annum and the “total” return is slightly less than 2.0%. UGLY! Obviously, the end of the 10-year period multiple is the key to the return calculation. But all in all, the low returns that most investment firms (including Goldman) are forecasting seem to be in the right neighborhood given these expectations.

Given the potential challenges for Pension America to achieve the desired return (ROA objective) outcome, a cash flow matching (CFM) strategy will help a pension plan bridge this potentially difficult period. Importantly, by having the necessary liquidity to meet monthly benefits and expenses, assets won’t have to be sold to meet those obligations thus eliminating the potential to lock in losses. Lastly, the roughly 5% yield-to-worse (YTW) on the CFM portfolio looks to be superior to future equity returns – a win/win!

It just might be time to rethink your plan’s asset allocation. Don’t place all of your assets into one return bucket. Explore the many benefits of dividing pension assets into liquidity and growth buckets. Want more info? Ryan ALM, Inc. has a ton of research on this idea. Please go to RyanALM.com/research.

10.08.24
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Milliman: Corporate Pension Funding Weakens in September

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

Milliman has released the latest results for the Milliman 100 Pension Funding Index (PFI). This index reviews the funding status each month of the top 100 U.S. corporate pension plans. The report indicated that the funded ratio declined to 102.4% at month-end from 102.6% at the end of August. Plan assets increased as a result of a 1.74% investment gain, but the discount rate declined by 0.14% to 4.96%. As a result, the growth in liabilities eclipsed asset growth leading to a $12 billion loss in funded surplus.

Assets for these combined plans now total $1.36 trillion as of September 30, while the projected benefit obligation is now $1.33 trillion giving these 100 corporate plans a $29 billion surplus. According to Zorast Wadia, author of the PFI, the current discount rate at 4.96% marks the first time since April 2023 that the rate hasn’t been >5.0%. However, so far in October we’ve witnessed a fairly significant move up in rates. If this trend continues, we could see the funded ratio for this index once again rising if the increase in rates doesn’t negatively impact the asset side of the pension equation.

10.08.24
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We Suggested That It Might Just Be Overbought

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

Regular readers of this blog might recall that on September 5th we produced a post titled, “Overbought?” that suggested that bond investors had gotten ahead of themselves in anticipation of the Fed’s likely next move in rates. At that time, we highlighted that rates had moved rather dramatically already without any action by the Fed. Since May 31, 2024, US Treasury yields for both 2-year and 3-year maturities had fallen by >0.9% to 9/5. By almost any measure, US rates were not high based on long-term averages or restrictive.

Sure, relative to the historically low rates during Covid, US interest rates appeared inflated, but as I’ve pointed out in previous posts, in the decade of the 1990s, the average 10-year Treasury note yield was 6.52% ranging from a peak of 8.06% at the end of 1990 to a low of 4.65% in 1998. I mention the 1990s because it also produced one of the greatest equity market environments. Given that the current yield for the US 10-year Treasury note was only 3.74% at that point, I suggested that the present environment wasn’t too constraining. In fact, I suggested that the environment was fairly loose.

Well, as we all know, the US Federal Reserve slashed the Fed Funds Rate by 0.5% on September 18th (4.75%-5.0%). Did this action lead bond investors to plow additional assets into the market driving rates further down? NO! In fact, since the Fed’s initial rate cut, Treasury yields have risen across the yield curve with the exceptions being ultra-short Treasury bills. Furthermore, the yield curve is positively sloping from 5s to 20s.

Again, managing cash flow matching portfolios means that we don’t have to be in the interest rate guessing game, but we are all students of the markets. It was out thinking in early September that markets had gotten too far ahead of the Fed given that the US economy remained on steady footing, the labor market continued to be resilient, and inflation, at least sticky inflation, remained stubbornly high relative to the Fed’s target of 2%. Nothing has changed since then except that the US labor market seems to be gaining momentum, as jobs growth is at a nearly 6-month high and the unemployment rate has retreated to 4.1%.

There will be more gyrations in the movement of US interest rates. But anyone believing that the Fed and market participants were going to drive rates back to ridiculously low levels should probably reconsider that stance at this time.

10.07.24
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ARPA Update as of October 4, 2024

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

Welcome to October. It is always a beautiful time of year in New Jersey.

With regard to the PBGC’s implementation of the ARPA legislation, there was some activity last week. After a short pause in accepting applications, the PBGC accepted two initial applications from two non-Priority Group members. Cement Masons Local No. 524 Pension Plan and the Roofers Local No. 75 Pension Plan, both Ohio-based, filed applications seeking $11.3 million combined in SFA for 486 plan participants. As a reminder, the PBGC has 120 days to act on those applications.

In addition to the 2 new applications, the PBGC recouped another $1.2 million in SFA overpayments due to census errors. This brings the repayment to of excess SFA to $144.1 million for 19 plans. The recovery of SFA amounts to 0.37% of the grant monies awarded. In other news, there were no applications approved, denied or withdrawn during the last week. There also were no funds seeking to be added to the waitlist.

As the chart above highlights, there are 110 funds yet to have applications approved. US Treasury yields are once again on the rise after a dramatic retreat as bond investors plowed into bonds anticipating very aggressive rate cuts by the Federal Reserve. Higher rates reduce the PV cost of those FV payments of benefits and expenses. A defeasement strategy significantly reduces interest rate risk as FVs are not interest sensitive. As we’ve discussed on many occasions, using a cash flow matching strategy to meet those benefits and expenses reduces the uncertainty associated with a traditional benchmark relative fixed income product. We are happy to discuss this subject in far greater detail.