Tag Archives: fppta

02.04.26
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How Do You Know?

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

I’m on my way home from another terrific FPPTA conference. The only issue I have is with the weather Gods. How is it that Orlando had weather similar to what New Jersey experiences during January? Yes, I was in a conference room from dawn to dusk, but it still wasn’t fair, especially since temps are set to hit 70+ today, while I’m now sitting at the airport. 

Okay, enough of my complaining. As mentioned, I just attended FPPTA’s Winter Trustee meeting in Orlando. They continue to do an excellent job providing critical education for trustees of all experience levels. As I’ve written, they have also developed a higher-level program for a select group of pension trustees that truly want to roll up their sleeves and like Dorothy and her friends, get behind the curtain. I’ve been fortunate to be a part of the first two TLC classes. As the FPPTA continues to develop their use of AI and the self-contained bot currently under construction, Florida public pension trustees will have critical information at their fingertips that few other states, if any, can provide. Great job!

Despite the robust curriculum, there is still much more that needs to be covered and comprehended by the trustees. For instance, there was a lot of discussion surrounding hiring and firing of managers during a particular case study. As I’ve observed over the years, the fortunate investment manager that gets hired usually has the best performance and a reasonable fee that doesn’t offset the performance advantage. Do pension trustees truly understand what they are buying? Often the manager selected is large and likely growing in terms of AUM. But are those advantages?

Worse, when a manager underperforms, which they will eventually do, whether that underperformance is related to a style rotation or something specific to that managers process, a decision must be made as to that manager’s fate. Do you keep the manager or let them go? On what basis are you making that decision? Again, you hired a manager because they had good performance. Did you understand their security selection process (insights) and how those insights were working? Did recent strong AUM growth fuel a positive response in the stocks that they owned? As we know, cycles in the investment industry are driven by cash flows, both positive and negative. More money chasing a few ideas drives up returns, while an exodus from those same ideas can tank an investment manager’s performance.

During one exchange of ideas, I asked the TLC participants if any of their funds were using performance fees for their long-only assignments. Only one trustee said that they had – too bad. We’ll discuss that issue in another post. Regarding the one affirmative response, they initiated a performance fee after an extended period of underperformance. Was that action correct? Paying asset-based fees with no promise of delivery on forecasted alpha is wrong, but retaining an underperforming manager may be just as bad whether they are on a performance fee or not. How did this trustee and his fellow board members know whether the manager had skill or if they once did, were their insights still robust?

Investment managers choose their portfolio holdings based on certain insights, and those insights can be measured as to their predictive ability (information coefficient or IC). An information coefficient is the correlation between predicted returns (or rankings of one stock versus another) and the subsequent results (realized returns). If an advisor is a growth manager, they likely swim in a subset of the U.S. equity universe. They then apply their insights to that subset of equity stocks. Each month they can array their portfolio holdings with the balance of the names in the universe that they did not select to see how their ideas stacked up.

You might be surprised to read that a monthly IC above 0.05% is considered fairly strong. An IC from 0.05% to 0.15% would be very strong and likely lead to consistent alpha generation. However, even the best investment ideas can go through challenging times when market dynamics are just out of whack with historic observations and relationships. But there are also times when ideas can get arbitraged away either by that managers growth or the broader investment community latching onto the same insight rendering it less effective or in some cases a negative forecaster/predictor.

So, I ask, when your manager is underperforming, do you know whether it is a market dynamic that is rendering the insight temporarily weak or has that manager’s forecasting ability been diminished? In the case of the manager who maintains strong forecasting ability, but the insight is just out of favor, you would likely want to retain them after a period of underperformance and maybe give them more assets to manage, but I would not recommend putting them on a performance fee (regression to the mean tendencies). However, if after your careful analysis you identify that the manager in question has seen their insights arbitraged away, that should lead you to terminate the manager, whether you like them or not! Let me know if you’d like to discuss his concept in greater detail.

10.08.25
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An Alternative Pension Funding Formula

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

I’ve spent the last few days attending and speaking at the FPPTA conference in Sawgrass, Florida. As I’ve reported on multiple occasions, I believe that the FPPTA does as good a job as any public fund organization of providing critical education to public fund trustees. A recent change to the educational content for the FPPTA centers on the introduction of the “pension formula” as one of their four educational pillars. In the pension formula of C+I = B+E, C is contributions, I is investment income (plus principal appreciation or depreciation), B is benefits, and E represents expenses.

To fund B+E, the pension fund needs to contribute an annual sum of money (C) not covered by investment returns (I) to fully fund liability cash flows (B+E). That seems fairly straightforward. If C+I = B+E, we have a pension system in harmony. But is a pension fund truly ever in harmony? With market prices changing every second of every trading day, it is not surprising that the forecasted C may not be enough to cover any shortfall in I, since the C is determined at the start of the year. As a result, pension plans are often dealing with both the annual normal cost (accruing benefits each year) and any shortfall that must be made up through an additional contribution amortized over a period of years.

As a reminder, the I carries a lot of volatility (uncertainty) and unfortunately, that volatility can lead to positive and negative outcomes. As a reminder, if a pension fund is seeking a 7% annual return, many pension funds are managing the plan assets with 12%-15% volatility annually. If we use 12% as the volatility, 1 standard deviation or roughly 68% of the annual observations will fall between 7% plus or minus 12% or 19% to -5%. If one wants to frame the potential range of results at 2 standard deviations or 19 out of every 20-years (95% of the observations), the expected range of results becomes 31% to -17%. Wow, one could drive a couple of Freightliner trucks through that gap.

Are you still comfortable with your current asset allocation? Remember, when the I fails to achieve the 7% ARC the C must make up the shortfall. This is what transpired in spades during the ’00s decade when we suffered through two major market corrections. Yes, markets have recovered, but the significant increase in contributions needed to make up for the investment shortfalls haven’t been rebated!

I mentioned the word uncertainty above. As I’ve discussed on several occasions within this blog, human beings loathe uncertainty, as it has both a physiological and mental impact on us. Yet, the U.S. public fund pension community continues to embrace uncertainty through the asset allocation decisions. As you think about your plan’s asset allocation, is there any element of certainty? I had the chance to touch on this subject at the recent FPPTA by asking those in the room if they could identify any certainty within their plans. Not a single attendee raised their hand. Not surprising!

As I result, I’d like to posit a slight change to the pension formula. I’d like to amend the formula to read C+I+IC = B+E. Doesn’t seem that dramatic – right? So what is IC? IC=(A=L), where A are the plan’s assets, while L= plan liabilities. As you all know, the only reason that a pension plan exists is to fund a promise (benefits) made to the plan participant. Yet, the management of pension funds has morphed from securing the benefits to driving investment performance aka return, return, and return. As a result, we’ve introduced significant funding volatility. My subtle adjustment to the pension formula is an attempt to bring in some certainty.

By carefully matching assets to liabilities (A=L) we’ve created an element of certainty (IC) not currently found in pension asset allocation. By adding some IC to the C+I = B+E, we now have brought in some certainty and reduced the uncertainty and impact of I. The allocation to IC should be driven by the pension plan’s funded status. The better the funding, the greater the exposure to IC. Wouldn’t it be wonderful to create a sleep-well-at-night structure in which I plays an insignificant role and C is more easily controlled?

To begin the quest to reduce uncertainty, bifurcate your plan’s assets into two buckets, as opposed to having the assets focused on the ROA objective. The two buckets will now be liquidity and growth. The liquidity bucket is the IC where assets and liabilities are carefully matched (creating certainty) and providing all of the necessary liquidity to meet the ongoing B+E. The growth portfolio (I) are the remaining plan assets not needed to fund your monthly outflows.

The benefits of this change are numerous. The adoption of IC as part of the pension formula creates certainty, enhances liquidity, buys-time for the growth assets to achieve their expected outcomes, and reduces the uncertainty around having 100% of the assets impacted by events outside of one’s control. It is time to get off the asset allocation and performance rollercoaster. Yes, recent performance has been terrific, but as we’ve seen many times before, there is no guarantee that continues. Adopt this framework before markets take no prisoners and your funded status is once again challenged.