Tag Archives: stocks

01.29.25
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What A Challenging Job!

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

I’m going to divert from my normal focus on cash flow matching (CFM) and the defeasing of pension liabilities to write about a subject that I love and one that doesn’t get nearly the air time that it should. I was reminded of this topic at the FPPTA’s latest TLC program in Orlando, which I’ve thoroughly enjoyed participating. If you aren’t aware of the TLC (Thought Leadership Council) this is the FPPTA’s newest advanced educational program for experienced pension trustees. The program is limited to 20-25 trustees who get to roll up their sleeves with highly experienced coaches/mentors. I’m grateful to be included.

On Monday, one of the discussions centered on active managers, particularly US domestic equity managers, who have an incredibly challenging job trying to outperform their respective benchmarks, especially given the concentrated nature of the U.S. equity stock market during the last couple of years. Asset consultants have an even more challenging job trying to figure out which of those active asset managers will actually provide alpha NET of fees. As mentioned during one particular session, there are many aspects of the investment management process that are evaluated by consultants in an attempt to try and identify those few outperformers. These screening criteria may include the depth and consistency of staff, overall experience in managing the strategy, AUM in the product, and of course, performance. However, just because a manager outperformed (provided an excess return vis-a-vis the benchmark) an index at one point doesn’t mean it will happen again. Was the outperformance the result of skill or luck or a little of both?

As I explained to the TLC participants, stock selection factors (indicators or ideas) used to “pick” stocks to be included in the manager’s portfolio have an information content that can be measured. The “value-added” from an idea/factor can ebb and flow depending on a number of factors. Is the “deterioration” in the information coefficient (IC) an indication that the factor is losing it’s forecasting ability or is it just currently out of favor? As investment management firms get larger, the AUM that they control can overwhelm those insights diminishing the forecasting ability of that idea. Other investment management firms have bright people looking for an edge, too. They might just capture the same or similar insights rendering everyone’s use of that idea less robust, which I witnessed first hand in 2007’s quant manager meltdown. Below are two posts that touch on this topic. I hope that my ideas prove useful to you. 

Change Is Good – Really!

and,

If it is That Good, Why Disclose it?

In a previous life, I was the CEO of Invesco’s quant business, which featured roughly 50 incredibly bright team members located both here and abroad and we managed about $30 billion in AUM. During our time together, we developed roughly 55 different strategies (optimizations), mostly U.S. equity mandates for which we had specific return/risk characteristics such as our Structured Core Equity product that was designed to achieve a 2% return for a 3% tracking error or a 0.67 information ratio versus the S&P 500.

We also thought that it was critically important to determine what we believed was the natural capacity of each strategy, as we didn’t want to arbitrage away our own insights. For instance, our Small Value product’s capacity was <$500 million, while many of the larger cap offerings had abundant capacity equal to billions of $s. Trustees should ask their managers what they believe is the natural capacity of the strategy(ies) that they are invested in and how they determined it.

Lastly, I would ask each manager to discuss a stock selection idea (factor / indicator) that they once used, but no longer do and why. Furthermore, I’d ask them to discuss an idea that they are now using to help them choose their portfolio constituents that they might not have been using 3-5 years ago. I’d make sure to understand how often they review every aspect of their investment management process. If that isn’t a normal part of their process, I’d be very concerned. For standing pat means that you are likely falling behind. It will be interesting to hear the replies.

Given how challenging it is to identify value-added managers as a consultant or consistently add value as an investment manager, I’m glad that Ryan ALM focuses on defeasing pension liability cash flows of benefits and expenses with asset cash flows from bonds (principal and interest). There is little uncertainty in our process. It is truly a sleep well at night strategy for all involved.

01.07.25
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Will You Do Nothing?

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

I recently read an article by Cliff Asness of AQR fame, titled “2035: An Allocator Looks Back over the Last 10 Years”. It was written from the perspective that performance for world markets was poor and his “fund’s” performance abysmal during that 10-year timeframe. His take-away: we can always learn from our mistakes, but do we? He cited some examples of where he and his team might have made “mistakes”, including:

Public equity – “It turns out that investing in U.S. equities at a CAPE in the high 30s yet again turned out to be a disappointing exercise”.

Bonds – “Inflation proved inertial” running at 3-4% for the decade producing lower real returns relative to the long-term averages.

International equities – “After being left for dead by so many U.S. investors, the global stock market did better with non-U.S. stocks actually outperforming”.

Private equity – “It turned out that levered equities are still equities even if you only occasionally tell your investors their prices”. When everyone is engaged in pursuing the same kind of investment there is a cost.

Private credit – “The final blow was when it turned out that private credit, the new darling of 2025, was just akin to really high fee public credit” Have we learned nothing from our prior CDO debacle?

Crypto – “We had thought it quite silly that just leaving computers running for a really long time created something of value”. “But when Bitcoin hit $100k we realized that we missed out on the next BIG THING” (my emphasis) “Today, 10 after our first allocation and 9 years after we doubled up, Bitcoin is at about $10,000.”

Asness also commented on active management, liquid alts, and hedge funds. His conclusion was that “the only upside of tough times is we can learn from them. Here is to a better 2035-2045”

Fortunately, you reside in the year 2025, a year in which U.S. equities are incredibly expensive, U.S. inflation may not be tamed, U.S. bonds will likely underperform as interest rates rise, the incredible push into both private equity and credit will overwhelm future returns, and let’s not discuss cryptos, which I still don’t get. Question: Are you going to maintain the status quo, or will you act to reduce these risks NOW before you are writing your own 10 year look back on a devastating market environment that has set your fund back decades?

As we preach at Ryan ALM, Inc., the primary objective when managing a DB pension plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. Continuing to invest today in many segments of our capital markets don’t meet the standard of low cost or of a prudent nature. Now is the time to act! It really doesn’t necessitate being a rocket scientist. Valuations matter, liquidity is critical, high costs erode returns, and no market outperforms always! Take risk off the table, buy time for the growth assets to wade through the next 10-years of choppy markets, and SECURE the promised benefits through a cash flow matching (CFM) strategy that ensures (barring defaults) that the promised benefits will be paid when due.

Thanks, Cliff, for an excellent article!

12.19.24
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5.6% 10-year forecast for US All-Cap

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

Fiducient Advisors has published its 2025 Outlook. Given the strong performance in US equity markets, future returns have been adjusted downward – rightfully so. Here are some of the highlights:

–Full valuations, concentrated U.S. large-cap indexes and the risk of reigniting inflation are shaping the key themes we believe will drive markets and portfolio positioning in 2025.

-Recent market successes have pushed our 2025 10-year forecasts lower across most major asset classes. Long-term return premium for equities over fixed income is now at its narrowest since 2007, sparking important conversations about portfolio posture and risk allocation.

–Rising reinflation risk leads us to increase our allocation to more flexible fixed income strategies (dynamic bonds) and TIPS while eliminating our global bond allocation.

US stock market performance has been heavily influenced by the “Magnificent Seven”, creating concentration risk not seen in decades, if ever. The outperformance of US markets vis-a-vis international markets is unprecedented. As stated above, valuations are stretched. Most metrics used to measure “value” in our markets are at extreme levels, if not historical. How much more can one squeeze from this market? As a result, Fiducient is forecasting that US All-Cap (Russell 3000?) will appreciate an annualized 5.6% for the next 10-years.

Nearly as weak are the forecasts for private equity, which Fiducient believes will produce only an annualized 8.6% return through the next 10-years. What happened to the significant “premium” that investing privately would provide? Are the massive flows into these products finally catching up with this asset class? Sure seems like it.

With regard to the comment about fixed income, I’m not sure that I know what “flexible fixed income strategies” are and the reference to dynamic escapes me, too. I do know that bonds benefit from lower interest rates and get harmed when rates rise. We have been very consistent in our messaging that we don’t forecast interest rates as a firm, but we have also written extensively that the inflation fight was far from over and that US growth was more likely to surprise on the upside than reflect a recessionary environment. Today, the third and final installment of the Q3’24 GDP forecast was revised up to 3.1% annual growth. The Q4’24 estimate produced by the Atlanta Fed through its GDPNow model is forecasting 3.2% annual growth. What recession?

Given that US growth is likely to be stronger, employment and wage growth still robust, and sticky inflation just that, bonds SHOULDN’T be used as a performance instrument. Bonds should be used for their cash flows of interest and principal. BTW, one can buy an Athene Holding Ltd (ATH) bond maturing 1/15/34 with a YTW of 5.62% today. Why invest in US All-Caps with a projected 5.6% return with all of that annual standard deviation when you can buy a bond, barring a default and held to maturity, will absolutely provide you with a 5.62% return? This is the beauty in bonds! Those contractual cash flows can be used, and have been for decades, to defease liabilities (pension benefits, grants, etc.) and to SECURE the promises made to your participants.

It is time to rethink the approach to pension management and asset allocation. Use a cash flow matching strategy to secure your benefits for the next 10-years that buys time for the growth assets to GROW, as they are no longer a source of liquidity. Equity markets may not provide the same level of appreciation as they have during the last decade (+13.4% annualized for the S&P 500 for 10-years through 11/30/24), but a defeased bond portfolio will certainly provide you with the necessary liquidity, an extended investing horizon, and the security (peace of mind) of knowing that your benefits will be paid as promised and when due! Who needs “flexible and dynamic” bonds when you have the security of a defeased cash flow matching strategy?

05.14.24
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What’s The Hurry?

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

“Fed To Cut Rates in September, Say Nearly Two-thirds of Economists.”

This pronouncement was in large bold font on an email that I received this morning from the Wealth Advisor. Should I be skeptical? You bet!!

As you may recall, there was near unanimity among “economists” late last year that the US Federal Reserve would begin reducing rates RAPIDLY as the calendar flipped to 2024. In fact, consensus was fairly strong that there were going to be 4-6 cuts of between 1.0%-1.5%. There was even a leading bank that saw the need to reduce rates by 2.5% – oh, my. What happened? At this time I’m particularly interested in the 1/3 of economists that were predicting huge cuts at the end of 2023 that aren’t buying a September cut at this time. Those are the ones that I want to hear from.

What has changed from late last year when the labor market was strong, inflation was sticky, economic growth was stronger than expected, the stock market was raging ahead, and fiscal policy was in direct conflict with the Fed’s monetary objectives? Nothing has changed!

What is the urgency to cut rates? The Atlanta Fed’s GDPNow model is predicting a 4.2% annualized growth rate for Q2’24 (latest update as of May 8th). Does a growth rate of that magnitude warrant a rate cut? Heck no! Yes, there is the issue that most of today’s investors don’t remember the 1970s, if they were even born, but I do. Fed missteps lead directly to incredibly high inflation and US interest rates. Today’s rate environment is nothing compared to that era. Why risk a repeat? Stagflation became a reality. Is that something that you want to witness again?

Seniors and those living on a fixed income can finally earn some interest on their investments without having to dive into strategies that they don’t understand just to earn a little more interest. Pension plans can finally use fixed income to secure some or all of their promises to plan participants by matching bond cash flows of interest and principal with pension liabilities (benefits and expenses). Endowments and foundations can invest more cautiously knowing that they can earn a return from less risky assets that will help them achieve a return commensurate with their spending policy. This is all good stuff! Use this environment to take some of your assets off the asset allocation rollercoaster before our capital markets reach the apex of their journey. The next downward trajectory could be a doozy!

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.

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?