Tag Archives: Asset allocation

09.23.24
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Liquidity Management Needs to be a Focus!

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

I’ve produced several posts addressing the important issue of liquidity for pension plans. You may recall my 8/14/24 post titled “A Liquidity Crunch?” that referenced issues within private equity as a result of the lack of distributions or the March 28, 2024 post titled, “The Importance of Liquidity”, which referred to a terrific article penned by Jack Boyce. There have been several others, but the issue isn’t being addressed with the appropriate urgency, so I’ll continue to elevate our concerns. As we’ve stated many times, the only reason that a pension plan exists is because of promised benefits that have been made to the plan participant. It is that promise that must be met each and every month upon retirement. There are costs associated with meeting this commitment, so both the benefit and those expenses must be funded effectively and efficiently. At present, they are not!

Is the above picture representative of the available liquidity in your plan? Has the significant movement into alternatives reduced for you the number of investment strategies within your asset allocation framework that can provide liquidity when called upon? Is the changing shape (steepening) of the US Treasury yield curve reducing the return available on cash thus making the holding of cash reserves less palatable? Has your practice of doing a “cash sweep” of dividends, interest, and capital distributions each and every month created headaches for you?

We’d like to speak with you about a strategy – cash flow matching (CFM) – that can dramatically improve your liquidity, while enhancing the return associated with “cash reserves” thus reducing the potential negative impact on your pursuit of the required ROA. Wouldn’t you like liquidity to be abundant similar to the picture below? How comforting would it be to know that each and every month your plan has the necessary asset cashflows to meet the liability cashflows of benefits and expenses without having to liquidate assets that may be transacted at less than opportune times?

Cash flow matching (CFM) has been around for decades. CFM is often how insurance companies and lottery systems meet their future obligations. They take a present value calculation of that future promise and they fund an investment grade bond program that will carefully match asset cash flows with the liability cash flows so that your required liquidity is available monthly. There is no need to do a cash sweep! If you aren’t familiar with Guinness Global Investors (UK), they have determined through their research that the practice of sweeping dividends is harmful (very) to long-term equity returns. In fact, they found that on a 10-year rolling basis going back to 1940, that dividends contributed 47% of the total return. More starkly, on a 20-year rolling basis, that contribution escalates to 57% – wow! The ability to reinvest those dividends into potentially higher returning equities is quite powerful. A CFM strategy will enable your plan to eliminate the ill effects of the cash sweeping practice and allow growth assets to grow unencumbered.

At Ryan ALM, Inc., liquidity management has always been a focus of ours since all we do is provide asset cash flows through our CFM product to meet those pesky monthly obligations. Let us help you craft a “liquidity policy” that makes sense. Furthermore, through our Custom Liability Index (CLI) we will map for you the needed liquidity as far into the future as you want to fund. Lastly, we’ll construct an investment grade bond portfolio that will ensure the necessary asset cash flows are available monthly (barring any defaults, which are incredibly rare within the IG universe). This portfolio should be the core holding within your plan. All other assets now have seen the investing horizon extended since they are no longer a source of liquidity. As you know, time is a critical variable in the success or failure of an investment program. The more time that one has to invest, the higher the probability of success. We stand ready to assist you.

09.18.24
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POB Discussions Back on the Table?

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

Cash Flow Matching (CFM) has enjoyed a renaissance within the pension community since US interest rates began rising in March 2022. The expanded use has not been limited to the beneficiaries of the Special Financial Assistance (SFA) paid through grants as a result of the ARPA pension reform being passed in March 2021. As a reminder, SFA proceeds are to be used exclusively to fund benefits (and expenses) as far into the future as the allocation will go. Protecting the precious grant proceeds has led to multiemployer pension plan sponsors and their advisors mostly using the 67+% in fixed income in defeasement strategies. We, at Ryan ALM, have certainly benefitted from this trend and applaud them for this decision.

In addition to multiemployer plans, both public and private (corporate) pension plans, as well as E&Fs have used CFM to bring an element of cash flow certainty (barring any defaults) to the management of pension assets and the generation of liquidity without being forced to sell assets, which can be very painful during periods of great uncertainty/volatility. These entities join insurance companies and lottery systems that have engaged in CFM activities for decades.

However, there remains a belief that CFM strategies only work during periods of high interest rates. We disagree, since liquidity is needed on a continuous basis. We believe that the use of CFM should be dictated by a number of factors, such as the entities funded status, ability to contribute, and the current fixed income exposure, as well as those liquidity needs. Unfortunately, it appears that interest rates have peaked for the time being. During the Summer of 2023, we were constructing CFM portfolios with a 6+% YTW, capturing most of the average ROA with little volatility. It was a wonderful scenario that unfortunately was not taken advantage of by most sponsors.

Today we are still able to build through our investment grade corporate bond focus portfolios with a YTW around 4.6%. Given the aggressive move down in Treasury yields during the last few months, we think that bond investors have gotten ahead of the Fed at this point as they are discounting about 150 bps of Fed rate cutting. Despite progress in the inflation fight, “sticky” inflation remains in excess of 4%. The US labor market’s unemployment rate is only 4.2%. Wage growth remains above 4%, while initial jobless claims remain at modest levels. Furthermore, the Atlanta Fed’s GDPNow model is forecasting growth for Q3’24 at 3.0% as of September 17, 2024. None of these metrics signal recession to me. How about you?

If you are of the mindset that a 4.6% YTW isn’t providing you with enough return, just think what you’d get from traditional active fixed income portfolios should rates rise once more. Please remember 2022’s -13% total return for the BB Aggregate Index. We frequently write about the need for plan sponsors to think outside the box as it relates to the allocation of assets. We believe that your plan’s assets should be bifurcated into two buckets – liquidity and growth. While the CFM portfolio is providing your plan with the necessary liquidity on a monthly basis, the growth assets can now grow unencumbered. These assets will be used at a later date to meet future benefits and expenses. With a CFM portfolio, plan sponsors can reduce or eliminate the need to do a “cash sweep” that takes away reinvestment in the growth portfolio.

In addition to believing that CFM is still a viable strategy in this environment, the decline in US Treasury yields is once again opening a door for sponsors to consider a pension obligation bond (POB). The 10-year Treasury Note yield is only 3.66% as of 6 pm EST (9/17) or roughly slightly more than half of the average public fund ROA. Estimates place the average funded ratio for public plans at 80%. For a plan striving for 7%, an 8.4% annual return must be created, or the plan’s funded status will continue to deteriorate unless contributions are increased to offset the shortfall. For plans that have funded ratios below the “average” plan, it is imperative that the deficit is closed more quickly. Issuing a POB and using the proceeds to close that gap is a very effective strategy. Corporate plans frequently issue debt and use the proceeds for a number of purposes, including the funding of pension funds.

We’d recommend once again that the proceeds received from a POB be used in a defeasement strategy to meet current liquidity needs and not invested in a traditional asset allocation framework with all of the uncertainty that comes from investing in our capital markets. Why risk potential losses on those assets when a CFM strategy can secure the Retired Lives Liability? It is truly unfortunate that most plan sponsors with underfunded plans didn’t take advantage of the historically low interest rates in 2020 and 2021. Cheap money was available for the taking. It is also unfortunate, that those plans that did take advantage of the rate environment likely invested those proceeds into the existing asset allocation. As you might recall, not only did the BB Aggregate decline -13% in 2022, the S&P 500 fell -18% that year, too.

Managing a DB pension plan comes with a lot of uncertainty. At Ryan ALM, we are trying to bring investment strategies to your attention that will provide certainty of cash flows, which will help stabilize the fund’s contributions and funded status. Don’t be the victim of big shifts in US interest rate policy. Use bonds for their cash flows and secure the promises for which your plan exists in the first place. A defeasment strategy mitigates interest rate risk because the promises (benefits and expenses) are future values, which are not interest rate sensitive. That should be quite comforting. Let us know how we can help you. We stand ready to roll.

07.26.24
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Sometimes You Just Have To Shake Your Head

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

CIO Magazine recently published an article chronicling the trials and tribulations of the Dallas Police and Fire and Dallas Employees pension systems. This is not the first time that these systems have been highlighted given the current funded status of both entities, especially the F&P plan currently funded at 39%. The article was based on a “commissioned” study by investment adviser Commerce Street Investment Management, that compiled and in June presented its report to the city’s ad hoc committee on pensions. According to the CIO Magazine article, they were “tasked with assessing the pension funds’ structure and portfolio allocation; reviewing the portfolios’ performance and rate of return; and evaluating the effectiveness of the pension funds’ asset allocation strategy.” That’s quite the task. What did they find?

Well, for one thing, they were comparing the asset allocation strategies of these two plans with similarly sized Texas public fund plans, including three Houston-based systems: the Houston Firefighters’ Relief and Retirement Fund, the Houston Police Officers’ Pension System, and the Houston Municipal Employees Pension System. The practice of identifying “peers” is a very silly concept given that each system’s characteristics, especially the pension liabilities, are as unique as snowflakes. The Dallas plans should have been viewed through a very different lens, one that looked at the current assets relative to the plan’s liabilities.

Unfortunately, they didn’t engage in a review of assets vs. liabilities, but they did perform an asset allocation review that indicated that the two Dallas plans did not have enough private equity which contributed to the significant underfunding. Really? Commerce Street highlighted the fact that “Houston MEPS’ private equity allocation is 28.2%, and the average private equity allocation among the peer group is 21.3%, compared with the DPFP and Dallas ERF’s allocations of 12.2% and 10.5%, respectively.” How has private equity performed during the measurement period? According to the report, Dallas P&F’s plan performed woefully during the 5-years, producing only a 4.8% return, which paled in comparison to peers. Was it really a bad thing that Dallas didn’t have more PE based on the returns that its program produced?

Why would the recommendation be to increase PE when it comes with higher fees, less liquidity, little transparency, and the potential for significant crowding out due to excess migration of assets into the asset class? During the same time that Dallas P&F was producing a 4.8% 5-year PE return, US public equities, as measured by the S&P 500, was producing a 15.7% (ending 12/31/23) or 15.1% 5-year return ending 3/31/24. It seems to me that having less in PE might have been the way to go.

The Commerce report recommended that “to improve the pension funds’ returns and funded ratios, the city should: analyze what top performing peers have done; collaborate to find new investment strategies; improve governance policies and procedures; and provide recommendations for raising the funds’ investment performance.” Well, there you have it. How about returning to pension basics? Dallas is going to have to contribute significantly more in order to close the funding gap. They are not going to be able to create an asset allocation that will dramatically outperform the ROA target. Remember: if a plan is only 50% funded, achieving the ROA will result in the funded status deteriorating even more. They need to beat the ROA target by 100% in order to JUST maintain the deficit.

I’ve railed about pension systems needing to get off the asset allocation rollercoaster to ruin. This recommendation places the Dallas systems on a much more precarious path. So much for bringing some certainty to the management of pension plans. No one wins with this strategy. Not the participant, sponsor, or the taxpayers.

07.23.24
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Oh, The Games That Are Played!

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

Managing a defined benefit pension plan should be fairly straightforward. The plan sponsor has made a promise to each participant which is based on time of service, salary, and a multiplier as the primary inputs. The plan sponsor hires an actuary to do the nearly impossible of predicting the future benefits, administrative expenses, salaries, mortality, etc., which for the most part, they do a terrific job. Certainly in the short-term. Since we have a reasonable understanding of what that promise looks like, the objective should be to SECURE that promise at a reasonable cost and with prudent risk. Furthermore, sufficient contributions should be made to lessen the dependence on investment returns, which can be quite unstable.

Yet, our industry has adopted an approach to the allocation of assets that has morphed from focusing on this benefit promise to one designed to generate a target return on assets (ROA). In the process, we have placed these critically important pension funds on a rollercoaster of uncertainty. How many times do we have to ride markets up and down before we finally realize that this approach isn’t generating the desired outcomes? Not only that, it is causing pension systems to contribute more and more to close the funding gap.

Through this focus on only the asset-side of the equation, we’ve introduced “benchmarks” that make little sense. The focus of every consultant’s quarterly performance report should be a comparison of the total assets to total liabilities. When was the last time you saw that? Never? It just doesn’t happen. Instead, we get total fund performance being compared to something like this:

Really?

Question: If each asset class and investment manager beat their respective benchmark, but lost to liability growth, as we witnessed during most of the 2000s: did you win? Of course not! The only metric that matters is how the plan’s assets performed relative to that same plan’s liabilities. It really doesn’t matter how the S&P 500 performed or the US Govt/Credit index, or worse, a peer group. Why should it matter how pension fund XYZ performed when ABC fund has an entirely different work force, funded status, ability (desire) to contribute, and set of liabilities?

It is not wrong to compare one’s equity managers to an S&P or Russell index, but at some point, assets need to know what they are funding (cash flows) and when, which is why it is imperative that a Custom Liability Index (CLI) be constructed for your pension plan. Given the uniqueness of each pension liability stream, no generic index can ever replicate your liabilities.

Another thing that drives me crazy is the practice of using the same asset allocation whether the plan is 60% funded or 90% funded. It seems that if 7% is the return target, then the 7% will determine the allocation of assets and not the funded status. That is just wrong. A plan that is 90% funded has nearly won the game. It is time to take substantial risk out of the asset allocation. For a plan that is 60% funded, secure your liquidity needs in the short-term allowing for a longer investment horizon for the alpha assets that can now grow unencumbered. As the funded status improves continue to remove more risk from the asset allocation.

DB plans are too critically important to continue to inject unnecessary risk and uncertainty into the process of managing that fund. As I’ve written on a number of occasions, bringing certainty to the process allows for everyone involved to sleep better at night. Isn’t it time for you to feel great when you wake up?

06.25.24
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ARPA Update as of June 21, 2024

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

I suspect (can only hope) that you woke up yesterday morning just itching to see what news I was going to share as it related to ARPA and the PBGC’s implementation of that critical legislation. Sorry to have disappointed you. Like most everyone else, my day just got away from me.

However, I do have some exciting news to share which might just make up for the disappointment of having to wait one day to get the weekly update. As we’ve been writing, the PBGC was running up against many application review and determination deadlines this month. As a result, they have announced that five funds had their applications approved for Special Financial Assistance (SFA). Terrific!

The five funds are the Retail, Wholesale and Department Store International Union and Industry Pension Plan, the Bakery and Confectionery Union and Industry International Pension Fund, United Food and Commercial Workers Unions and Employers Midwest Pension Plan, GCIU-Employer Retirement Benefit Plan, and the Pacific Coast Shipyards Pension Plan. These funds represent three Priority Group 6 members and two that came through the non-priority waitlist. In total, they will receive nearly $5.8 billion in SFA for just over 200k in plan participants. The Kansas Construction Trades Open End Pension Trust Fund is the last application that needs action in June. There are four that have July deadlines.

There were no new applications submitted to the PBGC, as the portal remains temporarily closed, no applications denied or withdrawn, and none of the plans that have received SFA were forced to return a portion of the proceeds as a result of overpayment identified through a death audit of the plan’s population.

Fortunately, the US interest rate environment and current economic conditions remain favorable for those potential SFA recipients to SECURE promised benefits far into the future without subjecting the grant proceeds to unnecessary risk associated with a non-cash flow matching assignment. Remember that the sequencing of returns is a critical variable when contemplating an asset allocation framework. If your SFA portfolio suffers significant losses in the early years, you negatively impact the coverage period. We’ll be happy to model your plan’s liabilities for free. Don’t hesitate to reach out to us if we can be a resource for you.

06.07.24
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Money Managers Recaptured 1/2 the 2022 losses – Should We Be Pleased?

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

P&I has produced an article highlighting the fact that money managers recaptured nearly half of the institutional assets lost (-$9 trillion) in 2022’s market correction. They mention that this was accomplished despite “lingering economic and political uncertainties that kept a lot of money sidelined, including a record $6 trillion parked in money market funds alone.”

According to Pensions & Investments’ 2023 survey of the largest money managers, institutional assets for 411 managers around the globe rose 9.7%, or $4.89 trillion, to $55.23 trillion as of Dec. 31, 2023 for a recovery rate of 52.5%. This recapture of assets was primarily driven by equities, both US (+26%) and global X US (+18%), while bonds were up 5.6% domestically and abroad.

Obviously, it was great to see the “rally” despite wide-spread uncertainty related to the economy, inflation, interest rates, and the labor market. Issues that are still impacting perceptions today. But the real question one should ask has to do with the cyclical nature of markets and what plan sponsors and their advisors can do to mitigate the peaks and valleys. As I reported earlier this week, since 2000, public pension plans have seen a tripling (or more) in contribution expenses as a % of pay, while the funded status of Piscataqua research’s universe of 127 state and local plans has fallen by 25%.

Isn’t it time to get off the asset allocation rollercoaster? The nearly singular focus on return (ROA) by pension plan sponsors has placed pension funding on a ride that does little to guarantee success, but has certainly exacerbated volatility. In the process, contributions into these critically important retirement systems have skyrocketed. Let’s stop thinking that the only way to fund pensions is through outsized market returns. Today’s interest rate environment is providing plan sponsors with a wonderful opportunity to SECURE a portion of their future promises by carefully constructing a defeased bond portfolio that matches and funds asset cash flows of principal and interest with liability cash flows of benefits and expenses.

By doing so, you eliminate the impact of drawdowns, as the assets and liabilities will now move in tandem. How refreshing! Because you are defeasing a future benefit, you are also eliminating interest rate risk, as future values are not interest rate sensitive. Furthermore, you have now created a liquidity profile that is enhanced, as the bond portfolio now pays all of the benefits and expenses chronologically as far into the future as the allocation to the cash flow matching program lasts. Lastly, the growth or alpha assets can now grow unencumbered, as they are no longer a source of funding. The need for a cash sweep has been replaced by cash flow matching with bonds.

Let’s stop having to celebrate recovery rates of roughly 50%, when we can institute investment programs that eliminate these massive and harmful drawdowns. They aren’t helpful to the sustainability of DB pension plans, which we so desperately need if we are to provide a dignified retirement to the American worker. Let’s get back to the fundamentals, as the true objective of a pension is to fund benefits in a cost-efficient manner with prudent risk. It isn’t a performance arms race!

06.05.24
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The Status Quo Isn’t Working

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

Anyone who has read just a handful of the >1,400 blog posts that I’ve produced knows that I am a huge fan of defined benefit (DB) plans. That I’ve come to loathe the fact that DB plans were/are viewed as dinosaurs, and as a result have been mostly replaced by ineffective defined contribution plans. As a result, the American worker is less well-off given the greater uncertainty of their funding outcome. A dignified retirement is getting further out of reach for a majority of today’s workers.

That said, just because I desire to see DB plans maintained as the primary retirement vehicle, doesn’t mean that I appreciate how many of them have been managed. The pension plan asset allocations remain focused on the wrong objective, which continues to be the ROA and NOT the plan’s liabilities. It is this mismatch in the primary objective that has exacerbated the volatility of the funded ratio/status and contribution expenses. As I’ve stated many times, it is time to get off the asset allocation rollercoaster. We need to bring an element of certainty to the investment structure despite the fact that outcomes within the capital markets are highly uncertain.

How bad have things been? According to a recently produced analysis by Piscataqua Research, Inc., which regularly reviews the performance of both assets and liabilities for 127 state and local retirement systems, since 2000 contributions as a % of pay have tripled, while funded status has declined by more than 25%. Again, I’m not here to bash public funds. On the contrary, I am here to offer a potential solution to the volatility exhibited. I wrote a piece many years (1/17) ago titled, “Perpetual Doesn’t Mean Sustainable” in which I discussed the need to bring stability to these critically important retirement plans because at some point there might just be a revolt from the taxpayers that are lacking defined benefit participation themselves. We can’t afford to have tens of millions of American public fund workers added to the federal social safety net God forbid their retirement plans are terminated and benefits frozen prematurely.

There is only one asset class – bonds – in which the future performance is known on the day that the bond is acquired. You can’t tell me what Amazon or Tesla will be worth in 10 years or the value of a building or private equity portfolio, but I can tell you how much interest and principal you will have earned on the day that the bond matures, whether that be 3-, 5-, 10- or 30-years from now. That information is incredibly valuable and can be used to match and SECURE the pension plan’s liabilities. That portion of the plan’s assets will now provide stability and certainty reducing the ups and downs exhibited through normal market behavior. Why continue to embrace an asset allocation that has NO certainty? An asset allocation that can create the explosion in contribution expenses that we’ve witnessed.

DB plans need to be protected and preserved! Ryan ALM’s focus is solely on achieving that lofty goal. It should be your goal, too. Let us help you get off the asset allocation rollercoaster before markets reach their peak and we once again ride those market down creating a funding deficit that will take years and major contributions to overcome.

05.01.24
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CFM: Buy Time and Reduce Risk

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

A traditional DB plan’s asset allocation comes with a lot of annual volatility (see the graph below). That volatility gets reduced as one extends the investing horizon, but it is still quite uncertain until you extend sufficiently, such as 10 or more years. However, as plan sponsors and investment managers, we have been living in a quarter-to-quarter measurement cycle for decades. In that environment, a 1 standard deviation (1 SD) measurement for a 1-year time frame (Ryan ALM asset allocation model since 1999) is +/- 10.5%. In the example below, 68% of the observations (1 SD) will fall between 16.5% and -4.5%. A 2 SD measurement would have the range for 95% of the observations between 27% and -15%. That gap, or should I say canyon, is a 1-year observation. Extend the measurement period to 5-years and the range of results is still wide but less so at +/- 9.8% for 2 SDs. It isn’t until you get beyond 10 years that the volatility associated with a fairly traditional asset allocation gets to a reasonable level.

Is there a way to bring more certainty to the asset allocation process that would allow for longer observation periods and less volatility? Absolutely! A plan sponsor and their advisors can adopt a bifurcated asset allocation in which a liquidity bucket is created that will fund and match the plan’s liability cash flows of benefits and expenses chronologically from the next month as far out as the allocation will cover (10+ years) allowing for the remainder of the alpha assets (all non-bond assets) to now grow unencumbered. The task for those assets is to meet future liabilities.

As the graph below highlights, a carefully constructed cash flow matching (CFM) portfolio can help plan sponsors wade through the volatility associated with shorter timeframes. The CFM portfolio will consist of investment grade bonds whose cash flows of interest and principal will be matched to the liability cash flows. This process now ensures (absent defaults) that the necessary liquidity is available when needed as those future promises have been SECURED. The remaining assets can now be managed as aggressively as the plan’s funded status dictates.

With this process, short-term market dislocations will no longer impact the plan’s ability to meet its obligations. There will be no forced selling to meet benefit payments. The alpha assets can now grow without fear of being sold at an unreasonable level. The CFM program takes care of your needs while establishing a buffer (longer investing horizon) from market corrections that happen on a fairly regular basis. This structure should also lead to less volatility related to contributions and the plan’s funded status.

Given the elevated US interest rate environment, now is the time to engage in this process. CFM will provide a level of certainty that doesn’t exist in a traditional asset allocation. This is a “sleep well at night” strategy that should become the core holding for DB pensions. As I mentioned in an earlier blog post today, bonds should only be used for the cash flows they produce. They should not be used as total return-seeking instruments. Leave that task to the alpha assets that will benefit from a longer investing period.

04.30.24
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Healthier Than Ever? Nah!

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

P&I produced an article yesterday titled, “Corporate Pension Funds Are Fully Funded, Healthier Than Ever. Now What?” According to Milliman, corporate pension plans are averaging roughly a funded ratio of 106%. This represents a healthy funded status, but it is by no means the healthiest ever. One may recall that corporate plans were funded in excess of 120% as recently as 2000. In what might be more shocking news, public pension plans were too when using a market discount rate (ASC 715 discount rate). Today, those public pension plans have a funded status of roughly 80% according to Milliman’s latest public fund report.

The question, “Now what”? is absolutely the right question to be asking. Many corporate plans have already begun de-risking, as the average exposure to fixed income is >45% according to P&I’s asset allocation survey through November 2023. Unfortunately, public pension systems still sit with only about 18% exposure to US fixed income, preferring a “let it ride” mentality as equities and alternatives account for more than 75% of the average plan’s asset allocation. Is this the right move? No. The move into alternatives has dried up liquidity, increased fees, and reduced transparency. Furthermore, just because a public plan believes that its sponsor is perpetual, does that make the system sustainable? You may want to be reminded about Jacksonville Police and Fire. There are other examples, too.

Whether the pension plan is corporate, multiemployer, or public, the asset allocation should reflect the funded status. There is no reason that a 60% funded plan should have the same asset allocation as one that is 90% or better funded. All plans should have both liquidity and growth buckets. The liquidity bucket will be a bond allocation (investment grade corporates in our case) that matches asset cash flows to liability cash flows of benefits and expenses. That bucket will provide all of the necessary liquidity as far into the future as the pension system can afford. The remaining assets will be focused on outperforming future liability growth. These assets will be non-bonds that now have the benefit of an extended investing horizon to grow unencumbered. Forcing liquidity in environments in which natural liquidity has been compromised only serves to exacerbate the downward spiral.

Pension America has the opportunity to stabilize the funded status and contribution expenses. They also have the chance to SECURE a portion of the promises. How comforting! We saw this movie a little more than 20 years ago. Are we going to treat this opportunity as a Ground Hog Day event and do nothing or are we going to be thoughtful in taking appropriate measures to reduce risk before the markets bludgeon the funded status? The time to act is now. Not after the fact.

04.18.24
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What’s the Motivation?

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

There appears in the WSJ today an article stating that pension plans were pulling “hundreds of billions from stocks”. According to a Goldman analyst, “pensions will unload $325 billion in stocks this year, up from $191 billion in 2023″. We are told that proceeds from these sales will flow to both bonds and alternatives. First question: What is this estimate based on? Are average allocations now above policy normal levels necessitating a rebalancing? Are bonds more attractive given recent movements in yields?

Yes, equities have continued to rally through 2024’s first quarter, and the S&P 500 established new highs before recently pulling back. Valuations seem stretched, but the same argument could have been made at the end of 2023. Furthermore, US interest rates were higher heading into 2023’s fourth quarter. If bond yields were an attractive alternative to owning equities, that would have seemed the time to rotate out of equities.

The combination of higher interest rates and equity valuations have helped Corporate America’s pensions achieve a higher funded status, and according to Milliman, the largest plans are now more than 105% funded. It makes sense that the sponsors of these plans would be rotating from equities into bonds to secure that funded status and the benefit promises. Hopefully, they have chosen to use a cash flow matching (CFM) strategy to accomplish the objective. Not surprisingly, public pension plans are taking a different approach. Instead of securing the benefits and stabilizing the plan’s funded status and contribution expenses by rotating into bonds, they are migrating both equities and bonds into more alternatives, which have been the recipients of a major asset rotation during the last 1-2 decades, as the focus there remains one of return. Is this wise?

I don’t know how much of that estimated $325 billion is being pulled from corporate versus public plans, but I would suggest that much of the alternative environment has already been overwhelmed by asset flows. I’ve witnessed this phenomenon many times in my more than 40 years in the business. We, as an industry, have the tendency to arbitrage away our own insights by capturing more assets than an asset class can naturally absorb. Furthermore, the migration of assets to alternatives impacts the liquidity available for plans to meet ongoing benefits and expenses. Should a market correction occur, and they often do, liquidity becomes hard to find. Forced sales in order to meet cash flow needs only serve to exacerbate price declines.

Pension plans should remember that they only exist to meet a promise that has been made to the participant. The objective should be to SECURE those promises at a reasonable cost and with prudent risk. It is not a return game. Asset allocation decisions should absolutely be driven by the plan’s funded status and ability to contribute. They shouldn’t be driven by the ROA. Remember that alternative investments are being made in the same investing environment as public equities and bonds. If market conditions aren’t supportive of the latter investments, why does it make sense to invest in alternatives? Is it the lack of transparency? Or the fact that the evaluation period is now 10 or more years? It surely isn’t because of the fees being paid to the managers of “alternative” products are so attractive.

Don’t continue to ride the asset allocation rollercoaster that only ensures volatility, not success! The 1990’s were a great decade that was followed by the ’00s, in which the S&P 500 produced a roughly 2% annualized return. The ’10s were terrific, but mainly because stocks were rebounding from the horrors of the previous decade. I don’t know what the 2020s will provide, but rarely do we have back-to-back above average performing decades. Yes, the ’90s followed a strong ’80s, but that was primarily fueled by rapidly declining interest rates. We don’t have that scenario at this time. Why assume the risk?