Tag Archives: cash-flow-matching

04.29.24
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ARPA Update as of April 26, 2024

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

Can you believe that a 1/3 of 2024 will soon be behind us? It is finally feeling like Spring in NJ today.

There is not much to discuss regarding the PBGC’s implementation of the ARPA pension legislation. According to the latest update, there were no new applications filed, approved, denied, or withdrawn. However, there was one fund that received the SFA. United Food and Commercial Workers Union Local 152 Retail Meat Pension Plan, a Mount Laurel, NJ, plan received SFA and interest in the amount of $279.3 million for the more than 10k plan participants.

There currently are 114 names on the waitlist. Of those, 27 have been invited to submit applications. As the data above reflects, 8 of those applications have been approved, 12 are currently under review, while another 7 have been withdrawn presumably to have the submission corrected and resubmitted. In addition to that activity, 112 of the 114 funds have locked-in a valuation date for SFA measurement (discount rate). Ninety-two percent of those chose 12/31/22, while 2 have no lock-up and the other 9 have chosen dates between December 31, 2022 and November 30, 2023. As a reminder, the SFA is based on a series of discount rates. The lower the rate, the greater the potential SFA. Using the 10-year Treasury yield as a proxy for the discount rate, those plans locking in an evaluation date as of year-end 2022 have done alright, as the yield at the end of 2022 was 3.88%, while it currently stands at 4.63% (4/29 at 3:39 pm).

We’ll have to see if the others have faired as well. In the meantime, the higher US interest rates have certainly helped from an investment standpoint, as the current environment is providing 5%+ YTM investment grade bond portfolios. The higher rates reduce the cost of those future promises while extending the coverage period to secure benefits through a cash flow matching investment strategy.

04.24.24
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Tricky? Not Sure Why!

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

The WSJ produced an article on April 22, 2024 titled, “Path for 10-Year U.S. Treasury Yield to 5% Is Possible but Tricky” At the time of publication, the 10-year Treasury note yield was just under 4.7%. It is currently at 4.66%. Those providing commentary talked about the need to further reduce expectations for potential rate cuts of another 25 to 40 basis points. As you may recall, there were significantly greater forecasts of rate cuts at the beginning of 2024, but those have been scaled back in dramatic fashion.

Given the current inflationary landscape in which the Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in March and 3.5% annually, a move toward 5% for the US 10-year Treasury note’s yield shouldn’t be surprising or tricky. According to the graph below, the US 10-year yield has averaged a “real” yield of nearly 2% (1.934%) since 1984. A 2% inflation premium would place today’s 10-year Treasury note yield at roughly 5.6%.

Given the current economic conditions (2.9% GDP growth for Q1’24) and labor market strength (3.8% unemployment rate), it certainly doesn’t seem like the Fed’s “aggressive” action elevating the Fed Funds Rate from 0 to 5.5% today has had the impact that was anticipated. Inflation in 2024 has been sticky and may in fact be increasing. Should geopolitical issues grow in magnitude, inflation may get worse. These current conditions don’t say to me that a move to a 5% 10-year Treasury note yield should be tricky at all. As a reminder, the yield on this note hit 4.99% in late October 2023. Financial conditions have not gotten more restrictive since then.

Should the Treasury yield curve ratchet higher, with the 10-year eventually eclipsing 5%, plan sponsors would have a wonderful opportunity to secure the future promised benefits at significantly reduced cost in present value terms, especially if the cash flow matching portfolio used investment grade corporate bonds with premium yields. Although US corporate bond spreads are tight relative to average spreads, they still provide a healthy premium. Don’t let this rate environment pass without taking some risk from your plan’s asset allocation. We’ve seen that scenario unfold before and the outcome is scary.

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?