Tag Archives: cash-flow-management

07.18.24
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Different Levels of Certainty

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

A friend of mine in the industry emailed me a copy of Howard Marks’ latest memo titled, “The Folly of Certainty”. As they normally are, this piece is excellent. As regular readers of this blog know, I’ve encouraged plan sponsors and their advisors to bring more certainty to defined benefit plans through a defeasement strategy known as cash flow matching. I paused when I read the title, thinking, “oh, boy”, I’m at odds with Mr. Marks and his thoughts. But I’m glad to say after reading the piece that I’m not.

What Howard is referring to are the forecasts, predictions, and/or estimates made with little to no doubt concerning the outcome. He cited a few examples of predictions that were given with 100% certainty. How silly. Forecasts always come with some degree of uncertainty (standard deviation around the observation), and it is the humble individual who should doubt, to some degree, those predictions. I’ve often said that hope isn’t an effective investment strategy, but that thought doesn’t seem to have resonated with a majority of the investment community.

Ryan ALM’s pursuit of greater certainty is brought about through our ability to create investment grade bond portfolios whose cash flows match with certainty (barring a default) the liability cash flows of benefits and expenses. We accomplish this objective through our highly sophisticated and trade-marked optimization model. We are not building our portfolios with interest rate forecasts, based on economic variables that come with a very high degree of uncertainty. No, we build our portfolios based on the client’s specific liability cash flows and implement them in chronological order. Importantly, once those portfolios are created, we’ve locked in a significant cost reduction that is a function of the rate environment and the length of the mandate.

As stated previously, I have a great appreciation for Howard Marks and what he’s accomplished. He is absolutely correct when he questions any forecast that has little expectation for being wrong. In most cases, the forecaster is not in control of the outcome, which should lend itself to being more cautious. In the case of the Ryan ALM cash flow matching strategy, we are in control. Having the ability to bring some certainty in our pursuit of securing the promised benefits should be greatly appreciated by the plan sponsor community. Because of the uncertain economic environment that we are currently living in, bringing some certainty should be an immediate goal. Care to learn more?

03.28.24
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The Importance of Liquidity

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

I recently came across an article written by a friend of mine in the industry. Jack Boyce, former Head of Distribution for Insight, penned a terrific article for Treasury and Risk in July 2020. The title of Jack’s article was “We Need to Talk About the Armadillo in the Room”. It isn’t just a funny title, but an incredible simile for the two primary stages of a pension plan, notably the accumulation and decumulation stages of pension cash flows. The move from a positive cash flow environment to a negative cash flow environment creates a hump that is reminiscent of the shape of an armadillo.

I stumbled on an armadillo at TexPERS last summer and truthfully didn’t think at that time that I was looking at a pension funding cycle, but I’ll never look at an armadillo again without thinking about Jack’s comparison. But the most important aspect of Jack’s writing wasn’t that he correctly associated the funding cycle with a less than cuddly animal, it was the fact that he highlighted a critically important need for pension plan sponsors of all types – liquidity! I’ve seen far too often the negative impact on pension plans and endowments and foundations when appropriate and necessary liquidity is not available to meet the promises, whether they be a monthly benefit, grant, or support of operations.

The last thing that you want to have happen when cash is needed is to be forced to raise liquidity when natural liquidity is absent from the market. There have been many times when even something as liquid as a Treasury note can’t be sold. Just harken back to 2008, if you want a prime example of not being able to transact in even the most liquid of instruments. Bid/ask spreads all of a sudden resemble the Grand Canyon. As we, at Ryan ALM have been saying, sponsors of these funds should bring certainty to a process that has become anything but certain. Jack correctly points out that “a typical LDI approach focuses on making sure the market value of a plan’s assets and the present value of its liabilities move in lockstep.” However, too often “these calculations fail to factor in the timing of cash flows.” We couldn’t agree more. Where is the certainty?

His recommendation mirrors ours, in that cash flow matching should be a cornerstone of any LDI program. Using the cash flow of interest and principal from investment grade bonds to carefully match (defease) the liability cash flows secures the necessary liquidity chronologically for as long as the allocation is sustained. By creating a liquidity bucket, one buys time for the remaining assets in the corpus to now grow unencumbered. As we all know, time is an extremely important attribute when investing. I wouldn’t feel comfortable counting on a certain return over a day, week, month, year, or even 5 years. But give me 10-years or more and I’m fairly confident that the expected return profile will be achieved.

Jack wrote, “pension plan sponsors need thoughtful solutions”. We couldn’t agree more and have been bringing ideas such as this to the marketplace for decades. Like Jack, “we believe a CDI approach can simultaneously improve a plan’s overall efficiency and the certainty of reaching its long-term outcome.” Certainty is safety! We should all be striving for this attribute.