Tag Archives: ROA

06.16.15
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NJ’s Pension Battle – We Are All Losers

Last week the state Supreme Court of NJ ruled that the Christie administration had the right to reduce / eliminate the annual required contribution (ARC) for the public pension system, based on a constitutionally established practice that the responsibility to allocate public funds is embedded in the budget process. What appears to be a victory for Christie and NJ tax payers couldn’t be further from the truth!

In a pattern that has been repeated for nearly 20 years, one NJ “leader” after another has failed to make the necessary payments to adequately fund public pensions. By not making the full contribution again this year, we are once again kicking the proverbial can down the road.

Remember folks, the benefit that has been promised to our public fund employees is a LIABILITY that must be met. Not funding that liability only makes it more challenging for the pension plan in the long-term, as the plan loses the benefit of compounding returns / interest on each contribution.  Just think about the economic impact of not funding the $3.1 billion in 2015, especially if the plan would have earned the state’s presumed return on assets over the next 10-20 years.  By deferring that payment, we create a pay as you go system that is much more costly for everyone.

Furthermore, NJ’s pension issue isn’t just a matter of not making the annual required contribution. Why on earth would NJ’s pension officers decide to invest heavily in hedge funds / alternatives at the bottom of the market in 2009?  This decision has increased management costs, while returns on the funds have substantially underperformed cheap equity beta. DB plans have a relative objective (liabilities) and not an absolute objective (ROA). Using absolute product in a relative return environment makes little sense.

Our elected officials are kidding themselves If they think that the pension liability is somehow going away.  By not appropriately funding the liability now, they are only making it more difficult for the state the future.  Think that pensions are taking a big slug of NJ’s budget now, just wait for another 15-20 years.

06.10.15
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Next 10 years Could Really Challenge Your ROA Assumption – Are You Ready?

According to Standard & Poor’s Institutional Market Services, which polled 679 defined benefit plan sponsors, the median return on asset (ROA) assumption is 7.56%, down slightly from 2013.  How realistic is this objective?  According to Rob Arnott, sponsors will have a very difficult time in the near future meeting this objective. Arnott gave investors a gloomy forecast for medium-term returns at the Inside ETFs Europe conference recently, and urged the audience to think of a new way to attack the ROA challenge.

According to Arnott, “10-year forward-looking expected returns are unanimously low.” He is predicting that Core fixed-income stands at 0.5 percent real returns as well as long-dated inflation linked bonds. Long Treasuries will go barely above zero. U.S. equities are 1 percent above inflation, and small-caps also give 1 percent, despite their yield of 1.8 percent.

Furthermore, the “Growth of earnings and dividends over and above inflation is 1.3 percent, not the 5 percent or more that Wall Street wants us to believe,” said Arnott.

Importantly, these real return expectations are before fees, which for many active strategies would “eat” most of the potential gain. Arnott’s research found that the U.S. top-quartile active manager pockets 0.9371% of the “alpha” and only passes on 0.0629% on to the client.

The plan sponsor quest to meet the ROA challenge has also produced exceptional volatility.  In the next 10 years, volatility is likely to remain at these levels or increase, but it seems that the return won’t be there to compensate for that extra volatility.  Importantly, we believe that liability growth is likely to be flat to negative during the next 10 years as interest rates rise, so a more conservative asset allocation may accomplish a sponsor’s funding goal.

We would suggest that a plan sponsor focus more attention on the plan’s liabilities to drive asset allocation decisions.  However, in order to accomplish this objective, the plan needs to have greater transparency on their liabilities.  Receiving an actuarial report every one or two years will not suffice.  In order to gain greater clarity, we would suggest that plans have a custom liability index (CLI) produced. The CLI will use various discount rates, and will provide a view with and without contributions factored in.  The CLI is provided on a monthly basis.

As a reminder, the only reason that a DB plan exists is to fund a benefit that has been promised in the future. Knowing how that benefit is changing on a regular basis should be a goal of every plan. We stand ready to provide you with the tools necessary to gain greater transparency on your plan’s liabilities, since it doesn’t seem that plan’s will win the funding game by generating outsized returns in the next decade.