Tag Archives: secure

05.01.24
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Another Challenging Month for US Fixed Income

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

S&P Dow Jones is out with its monthly “Dash Board” on a variety of benchmarks, both domestic and foreign. April proved challenging for both US equities and bonds. With regard to stocks, the S&P 500 was down -4.1% bringing the YTD performance to +6.04%. It was a tougher environment for both mid cap (-6.0%) and small cap (-5.6%). Small caps (S&P 600) continue to be pressured and the index is now down -3.3% YTD. As US interest rates continue on a course higher, US equities will continue to be challenged.

The higher US rates are also continuing to pressure US fixed income. The Aggregate Index produced a -1.8% April, and the index is now down -2.4% since the start of 2024 despite the rather robust YTM of 5.3%. As we’ve discussed on many occasions, bonds are the only asset class with a known cash flow of a terminal value and contractual coupon payments. As a result, bonds should be used for the certainty of those cash flows and specifically to defease pension liabilities. As a reminder, pension liabilities are bond-like in nature and they will move with changes in interest rates. Don’t use bonds as a total return strategy, as they will not perform in a rising rate environment. Sure, the nearly 40-year decline in rates made bonds and their historical performance look wonderful, but that secular trend is over.

Use the fixed income allocation to match asset cash flows of interest and principal to the liability cash flows of benefits and expenses. As a result, that portion of the total assets portfolio will have mitigated interest rate risk, while SECURING the promised benefits. Having ample liquidity is essential. Using bonds to defease pension liabilities ensures that the necessary liquidity will be available as needed. The current US interest rate environment may be pressuring total return-seeking fixed income managers, but it is proving cash flow matching programs with a very healthy YTM that dramatically reduces the cost of those future value payments. Don’t waste this golden opportunity.

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.