Maintain Your Asset / Liability Mismatch At Your Own Peril!!

Recent news from around the world indicates that growth is slowing in nearly every region. Japan and China are pumping liquidity into their systems to encourage more growth. Europe, an unmitigated disaster, will need to continue to provide stimulus, and not austerity, in order to get their citizens working and consuming. The US continues to plod along, but given our trading partners’ struggles, it would be naive of us to think that our ability to export goods won’t be negatively impacted.

With that said, US interest rates remain significantly above those of our partners in Europe and elsewhere, particularly in the 5- and 10-year space. The US rates provide real value relative to these other countries, and so it is likely that the value will be captured as investors seek those higher yields.

In the US pension arena, most plans continue to be dramatically underweight fixed income, as they fear higher rates and yields that are well below the ROA. Stop! The ROA isn’t the objective, and rates aren’t necessarily going higher. The only asset that moves in lock step with a pension plan’s liabilities is fixed income. We have a major funding issue in the US that will be exacerbated should rates continue to fall.

A new direction is needed in the day-to-day management of DB plans. Call us if you want to receive our insights.

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Delayed Gratification – Just How Important Is It?

The following Tweet was posted by Vanguard this morning – “Delaying gratification, avoiding debt, & saving are all central to a financial literacy program for student”. We all know that we are more responsible for funding our retirement than at any time in the last 60 years, but just because we know doesn’t mean we have the ability to do so.

Defined Contribution plans are the vehicles of choice for most private sector employers, if not their employees. However, funding these plans, even to meet the company match, is not easy for many (most) low to middle income households. At KCS, we’ve discussed the benefits of participating in a DB plan versus a DC plan since our founding.

But, if you have a job, don’t have substantial student loan our housing debt, and can afford to make sizable contributions into your retirement program, it is better to delay gratification and make those contributions as early and often as possible. Why? Because the math of compounding truly works.

For instance, if a 22 year old can make a monthly contribution of $833 for 10 years, the $99,960 in contributions growing at 4% / year will become $438,393.12 upon reaching age 65. Again, that is with making contributions for only the first 10 years. At that point, you’ve basically funded your retirement and now you can begin acquire some of the other assets that you’ve been deferring.

However, if you can’t fund your retirement upfront with sizable monthly contributions, but can only put in $194 / month for the next 43 years growing at 4% until age 65, your balance upon retirement would only be $256,648.87, or roughly $182,000 less in total assets. WOW!

Finally, just think about how little you’ll be able to accumulate in your account if you delay making contributions until the age of 32. For instance, if you can only make that $194 / month for the next 33 years your account balance at age 65 is only $154,500, more than $100,000 less than you would have had if you began contributing the $194 / mo for the prior 10 years.

So, DC plans need funding often and early to be successful, but having the financial wherewithal is not a given, and having the discipline is not easy.

Of Course They Are Going To Pick Above Average Managers!!

I had the pleasure of attending the Opal Conference in Newport, RI the last few days. Opal’s “Public Funds Summit East: Navigating the Future” was well attended by public fund trustees, asset consultants and investment management professionals. I will provide a general overview in a later blog post, but I want to dedicate this text to an issue related to investment management fees.

I was particularly disturbed by a comment by an asset consultant when the issue of performance fees was raised. This consultant was troubled by the notion of paying performance fees to managers of any ilk because managers are chosen by his firm who can and will add value, so why pay more for their services? How naive!

Just prior to this panel’s discussion, we were implored by a plan sponsor to seek economies of scale, while also being cognizant of fees (all fees, and not just investment manager fees), as they can be destructive to a plan’s long-term health. I absolutely agree.

Even if a consultant thought that a manager had the above average ability to provide an excess return on a fairly consistent basis, why would they or their clients be willing to pay a manager their full fee without the promise of delivery? As a reminder, the “average” manager will return the performance of the market minus transaction costs and fees.

It is fairly easy to calibrate the performance fee with the asset-based fee based on the expected excess return objective. If the manager achieves the return target, the fees paid should be roughly equivalent, with perhaps the performance fee relationship paying slightly more as compensation for the manager assuming more risk. However, in no case should the performance fee reward a manager to a much greater extent than the asset based fee would have generated.

If the manager truly has the ability to add consistent value, they should be comfortable assuming a performance fee. Importantly, the plan sponsor shouldn’t fear the injection of more risk into the strategy, as the manager is not likely interested in jeopardizing their reputation for a few more basis points. In addition, there are easy ways to track whether this is happening.

Lastly, paying flat asset-based fees in lieu of creating a more incentive based compensation structure is just wrong. Plans should be happy to pay fees based on value-add, but should be infuriated when forced to pay an asset-based fee for the usual less than index return.

KCS has a white paper on this topic that can be accessed on the KCS website. Don’t hesitate to reach out to us if you’d like to discuss this issue in greater detail. Asset consultants are kidding themselves (and their plan sponsor clients) if they think that they will only pick above average managers!

Double DB presented on Fox Business today

Double DB presented on Fox Business today

I had the pleasure to represent the Double DB pension alliance on Fox Business today.  We introduced the Double DB plan in a conversation with Adam Shapiro.  We hope that you find our conversation enlightening.  Ed Friend, Ron Ryan, Barry Gillman and KCS are looking forward to fielding your questions.  Enjoy!