Tag Archives: uncertainty

10.28.25
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Uncertainty versus Change

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

Seems like we have a conflict within the management of defined benefit plans. On one hand, human beings (plan sponsors) despise uncertainty. But nearly all public DB pension plans are embracing uncertainty in how they are managed. How? Through a traditional asset allocation framework that focuses the fund’s assets on a performance objective – the return on asset assumption (roughly 7% for the average public plan). Each second that the capital markets are operating, uncertainty is abundant, as price movements are out of one’s control. So let’s change how plans are managed. Not so simple, as those same human beings hate change. Oh, boy.

I have the privilege of speaking at the NCPERS Fall conference tomorrow. The title of my presentation is “Bringing an Element of Certainty to Pension Management”. Folks should absolutely eat up this topic, but given the conflict cited above, it will be interesting to see if the trustees in the audience embrace the concept of achieving some certainty despite having to implement change to their current operating practices.

Given that both uncertainty and change are difficult for humans, what are we to do? Well, psychological research suggests that uncertainty is generally more challenging because it disrupts our ability to predict, control, and prepare for outcomes, and in the process it triggers more anxiety and stress than change itself. According to the research:

  • Uncertainty introduces ambiguity about outcomes, which activates heightened anxiety in the brain. When people lack information about what will happen (such as market movements), they tend to experience more stress and feelings of helplessness.
  • Change, while uncomfortable, becomes easier to adapt to when the outcome is known, even if it’s negative. Humans can plan, adjust, and find coping strategies if they know what to expect. As a result, predictable change is less stressful than unpredictable change.

Why is uncertainty more challenging? Again, according to the research:

  • The human brain is wired to seek patterns and predict the future; uncertainty undermines this process, making adaptation feel more difficult.
  • Studies show that people prefer even certain bad news to ambiguous situations, because they can prepare for and process what’s coming.
  • Chronic uncertainty can lead to anxiety disorders and impaired decision-making, while change tends to prompt growth and learning once people know what they’re facing.

Uncertainty is usually more psychologically challenging than change because it creates anxiety about the unknown, whereas change with a known outcome—though still difficult—allows people to adapt and regain control. Given this reality, it would seem that reducing uncertainty within the management of a DB pension plan would outweigh the changes necessary to accomplish that objective. BTW, the changes needed aren’t great. All one needs to do to bring some certainty to the process is to convert the current core fixed income allocation to a cash flow matching (CFM) strategy that will SECURE the promised benefits for as far into the future as that allocation will cover. In the process you improve the fund’s liquidity profile and extend the investing horizon for the residual assets. A win/win!

How nice would it be to communicate to your plan participants that no matter what happens in the markets (uncertainty) the promised benefits are protected for the next 5-, 7-, 10- or more years. Talk about a “sleep well at night” strategy! Now that’s certainty that even change can live with.

03.26.25
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An Element of Certainty Can Be Achieved

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

I’ve spent the last few days attending my first GAPPT conference in Braselton, GA. The conference has been terrific as the venue is beautiful, the attendees/trustees delightful, and the speakers/topics topnotch. Senior, highly experienced members of our pension community have been sharing their insights on a variety of subjects. For those addressing the current state of our capital markets and pension asset allocation, the common theme has been uncertainty. Uncertainty as to the direction of equity markets, inflation, and interest rates. Furthermore, given that uncertainty, it should not be surprising that when asked about the direction of asset allocation trends going forward that the speaker would again claim that they don’t know. Of course not.

Regular readers of this blog know that I’ve addressed uncertainty in several blog posts. As human beings we despise uncertainty, yet the approach to pension management within the public sector has been to embrace uncertainty through a traditional asset allocation focused on a return on asset (ROA) target. We learned today that the ROA has fallen for the average public pension from 8% prior to the great financial crisis (GFC) to the current 6.9% today. Given the outsized returns provided by the public equity markets in recent years, funded ratios should have improved, but ironically, they are roughly at the same level they were at prior to the GFC. Yes, the lower discount rate increases the value of plan liabilities, which impacts the funded status, but it also increases contributions that should have offset some of that impact.

Instead of just accepting the fact that markets are uncertain, plan sponsors and their advisors should be seeking strategies to minimize that uncertainty, at least for a portion of the asset base. I know of only a couple of ways to bring certainty to the management of pension assets. One is through a pension risk transfer that shifts the liability from the plan sponsor to an insurance company. Given that public pension plans believe that they are perpetual, there is little appetite to terminate the DB plan. Furthermore, with funded ratios at roughly 75%, the cost to fully fund and then offload the liability would be prohibitive.

We, at Ryan ALM, want to see pensions protected and preserved. We don’t want our public workforce to be forced into managing their own retirements through a defined contribution offering. These vehicles have not worked for a significant majority of the private workforce, as asking untrained individuals to fund, manage, and then disburse a “benefit” with little to no disposable income, investment acumen, or a crystal ball to help with distributions is just poor policy.

So, what can sponsors do? They can adopt a cash flow matching (CFM) strategy that will defease (SECURE) pension liabilities by matching asset cash flows of interest and principal from bonds with the liability cash flows of benefits and expenses. This process is done chronologically from the first month of the assignment as far into the future as the allocation to the strategy will go. In the process of securing these promises, liquidity is enhanced allowing for the balance of the assets (alpha assets) to now grow unencumbered. As we all know, a long investing horizon enhances the probability of success for those alpha assets to achieve the expected outcome.

Isn’t it time to engage in a strategy that will provide the sponsors and their advisors with a better night’s sleep? Wouldn’t it be great if attendees at pension-related conferences learned that there is a strategy that can secure the promises given to plan participants? Given the elevated interest rate environment, CFM should become the core strategy within pension asset allocations. The allocation to CFM should be determined by multiple factors including the current funded status and the plan’s ability to contribute. We witnessed a failure on the part of sponsors back in 1999 to secure the promises when funded ratios were significantly > 100%. We aren’t at that level today, but an element of risk can be reduced and it should be. Let’s get these plans off the asset allocation rollercoaster and volatile funded status.

03.06.25
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Markets Hate Uncertainty

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

I’ve published many posts on the impact of uncertainty on the well-being of individuals and our capital markets. In neither case are the outcomes positive.

What we are witnessing in the last several trading days is the direct result of policy flip-flopping that is creating abundant uncertainty. As a result, the business environment is deteriorating. One can argue the merits of tariffs, but it is the flip-flopping of these policy decisions that is wreaking havoc. How can a business react to these policies when they change daily, if not hourly.

The impact so far has been to create an environment in which both investment and employment have suffered. Economic uncertainty is currently at record levels only witness during the pandemic. Rarely have we witnessed an environment in which capital expenditures are falling while prices are increasing, but that is exactly what we have today. Regrettably, we are now witnessing expectations for rising input prices, which track consumer goods inflation. It has been more than four decades since we were impacted by stagflation, but we are on the cusp of a repeat last seen in the ’70s. How comfortable are you?

We just got a glimpse of how bad things might become for our economy when the Atlanta Fed published a series of updates driving GDP growth expectations down from a high of +3.9% earlier in the quarter to the current -2.4% published today. The key drivers of this recalibration were trade and consumer spending. The uncertainty isn’t just impacting the economy. As mentioned above, our capital markets don’t like uncertainty either.

I had the opportunity to speak on a panel last week at Opal/LATEC discussing Risk On or Risk Off. At that point I concluded that little had been done to reduce risk within public pension plans, as traditional asset allocation frameworks had not been adjusted in any meaningful way. It isn’t too late to start the process today. Action should be taken to reconfigure the plan’s asset allocation into two buckets – liquidity and growth. The liquidity bucket will provide the necessary cash flow in the near future, while buying time for the growth assets to wade through these troubled waters. Doing nothing subjects the entire asset base to the whims of the markets, and we know how that can turn out.

02.26.25
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Risk On or Risk Off?

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

I have the pleasure of speaking at the Opal/LATEC conference on Thursday. My panel has been given the topic of Risk On or Risk Off: How Are You Adjusting Your Portfolio, and Which Investment Risks Concern You Most? I think it is an incredibly timely discussion given the many cross-currents in the markets today.

Generally speaking, what is risk? At Ryan ALM, Inc. we would say that risk is the failure to achieve the objective. What is the objective in managing a defined benefit pension plan? We believe that the primary objective is to secure the promised benefits at a reasonable cost and with prudent risk. We don’t believe that it is a return objective.

However, most DB pension systems are NOT focused on securing the promised benefits, but they are engaged in developing an asset allocation framework that cobbles together diversified (overly perhaps) asset classes and investment strategies designed to achieve an annual return (ROA) target that has been established through the contributions of the asset consultant, actuary, board of trustees, and perhaps internal staff, if the plan is of sufficient size to warrant (afford) an internal management capability.

Once that objective has been defined, the goal(s) will be carefully addressed in the plan’s investment policy statement (IPS), which is a road map for the trustees and their advisors to follow. It should be reviewed often to ensure that those goals still reflect the trustees’ wishes. The review should also incorporate an assessment of the current market environment to make sure that the exposures to the various asset classes reflect today’s best thinking.

There are numerous potential risks that must be assessed from an investment standpoint. Some of those include market (beta), credit, liquidity, interest rates, and inflation. For your international managers, currency and geopolitical risk must be addressed. From the pension management standpoint, one must deal with both operational and regulatory risk. Some of these risks carry greater weight, such as market risk, but each can have an impact on the performance of your pension plan.

However, there are going to be times when a risk such as inflation will dominate the investing landscape (see 2022). Understanding where inflation MAY be headed and its potential impact on interest rates and corporate earnings is a critical input into how both bonds and stocks will likely perform in the near-term. Being able to assess these potential risks as a tool to adjust your funds asset allocation could reduce risk and help mitigate the negative impact of significant drawdowns that will impact the plan’s funded status and contribution expenses. Of course, the ability to reduce or increase exposures will depend on the ranges that have been established around asset class exposures (refer to your IPS).

So, where are we today? Is it risk on or risk off as far as the investing community is concerned? It certainly appears to me that most investors continue to take on risk despite extreme equity valuations, sticky, and perhaps worsening inflation, leading to an uncertain path for U.S. interest rates, and geopolitical risk that can be observed in multiple locations from the Middle East, to Ukraine/Russia, and China/Taiwan. The recent change in the administration and policy changes related to the use of tariffs has created uncertainty, if not anxiety, among the investment community.

So, how are you adjusting your portfolio? If your plan is managed similarly to most where all the assets are focused on the ROA, the ability to adjust allocations based on the current environment is likely limited to those ranges that I described above. Also, who can market time? I would suggest that the best way to adjust your portfolio given today’s uncertainty is to adopt an entirely different asset allocation framework. Instead of having all of the assets focused on that ROA objective, bifurcate your asset allocation into liquidity and growth buckets.

By adopting this strategy, liquidity is guaranteed to be available when needed to make those pesky monthly benefit payments. In addition, you’ve just bought time, an extremely important investment tenet, for the remainder of the assets (growth/alpha) to now grow unencumbered. The liquidity bucket will provide a bridge over choppy waters churned up by underperforming markets. Yes, there appears to be significant uncertainty in today’s investment environment. Instead of throwing up your hands and accepting the risks because you have limited means to act, adopt the new asset allocation structure before it is too late to protect your plan’s funded status.

02.06.25
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Interesting Insights From Ortec Finance

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

PensionAge’s, Paige Perrin, has produced an article that referenced recent research from Ortec Finance. The research, which surveyed senior pension fund executives in the UK, US, the Netherlands, Canada, and the Nordics, found that 77% believe that risk will be elevated, either dramatically or slightly, in 2025. That’s quite the stat. It also follows on reporting from P&I that referenced heightened uncertainty by U.S. plan sponsors. As regular readers of this blog know, I’ve been suggesting to (pleading with) sponsors that they don’t need to live with uncertainty, which is truly uncomfortable.

Among several risks cited were interest rates, inflation, and market volatility. I can’t say that I blame them for their concerns. Who among us are able to adequately forecast rates and inflation? Seems like most fixed income professionals and bond market participants have been forecasting an aggressive move down in rates. Some of these prognosticators were forecasting as many as 7 rate reductions in 2024 and several others in 2025. We didn’t get 2024’s tally. Who knows about 2025 given that inflation has remained fairly sticky.

There is an easy fix for those of you who are concerned about interest rates and inflation. Adopt a cash flow matching (CFM) strategy that will carefully match asset cash flows of interest and principal with liability cash flows (benefits and expenses). Because benefit payments are future values (FVs), they are not interest rate sensitive. Problem solved! Furthermore, the use of CFM extends the investing horizon for the remainder of the fund’s growth assets, so they now have the appropriate time to grow to meet future liabilities.

One other startling stat caught my attention, as “77 per cent of senior pension fund executives believe the increasing number of retirees relative to the number of new hires in defined benefit (DB) plans pose a “significant” or “slight” risk to the DB pensions industry.” That concern is misplaced. I just wrote a post earlier this week on that subject. DB Pension plans are not Ponzi Schemes. They don’t need more depositors than those receiving payments. It is truly frightening that a significant percentage of our senior plan sponsors don’t understand how these plans are actuarial determined and subsequently funded.

Lastly, I nearly jumped out of my chair with excitement when I read the following quotes from Marnix Engels, Ortec Finance’s managing director for global pension risk, who stated the following:

“We believe assessing the risks of both (the bolding is my emphasis) assets and liabilities in combination is crucial to get the full picture on the health of a pension fund,” he said.

“If the impacts of risk drivers are only understood for one side of the funding health equation, then it is possible to misrepresent the overall effect.”

“If a fund is not assessing both assets and liabilities, then it is difficult to conclude the overall impact of interest rate hikes on the plan’s funding ratio.”

YES!!

12.18.24
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P&I: Asset Owner CIOs See Uncertainty in 2025

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

P&I is out with a story today about asset owner CIOs “forecasting” uncertainty for 2025. The capital markets are always uncertain. It only takes a “surprise” to disrupt even the most obvious trend. Given a new regime in Washington, stubborn inflation, geopolitical risks throughout the globe, and equity valuations that are stretched (that’s putting it mildly), CIOs have reason to be uncertain, especially over a short timeframe, such as a calendar year or two.

The lack of certainty can be destabilizing to individuals and investment strategies. I covered the psychology of uncertainty in a post earlier this year. Here were a few highlights:

  • When facing ongoing uncertainty, our bodies stay at a high level of physiological arousal, exerting considerable wear and tear.
  • Uncertainty exerts a strong pull on our thoughts and inhibits our ability to act, leaving us in a suspended waiting game.
  • We can manage uncertainty by figuring out what we can control, distracting ourselves from negative thoughts, and reaching out to others.

The last point is particularly important. We can manage “uncertainty” by figuring out what we can control. As a plan sponsor, we can utilize an investment strategy (cash flow matching or CFM) that creates certainty for the portion of the portfolio that uses CFM. In the following post, I question the significant use of equity and equity-like product in public pension systems that are accompanied by tremendous annual volatility. Again, this produces great uncertainty.

Adopting the use of greater fixed income exposure also doesn’t ensure less uncertainty, as changes in US interest rates can play havoc on fixed income strategies. ONLY with a CFM strategy do you bring certainty of cash flows (absent any defaults) to the management of pension plans. Traditional fixed income strategies benefited from a nearly 4-decade move down in rates, but there is currently great uncertainty as to the future direction of inflation and as a result, rates. With CFM one knows what the performance will look like a decade from now. With a fixed income strategy focused on a generic index, such as the BB Aggregate, one has no idea how that portfolio will perform 10 or more years from now.

Lastly, there is no reason to live with the uncertainty that many CIOs currently foresee. I wrote a piece just recently on achieving “peace of mind“. Uncertainty won’t help you in your quest for a good night’s sleep, but achieving peace of mind is very much achievable once you adopt a CFM strategy and secure the promised benefits (or grants) for some period of time. Call us. We want to remove as much uncertainty from your professional life as possible.