Still Think That They Are Performance Drivers?

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

Bonds enjoyed a nearly 4-decade bull market as U.S. interest rates plummeted from historic highs to an environment of negative real rates. It was unprecedented. As a result, bonds were perceived to be performance drivers. But are they?

We are often told by plan sponsors or their advisors that they can't invest in a cash flow matching (CFM) strategy because de-risking the portfolio will negatively impact the fund's ability to achieve the annual return on asset (ROA) assumption. Is that reality?

Facts:

• The Aggregate bond index has produced a -0.29% annualized return for the 5-years ending August 31, 2026!

• A CFM portfolio would have generated a return commensurate with its YTW (or YTM) during that 5-years. Shorter maturity (1-5-year defeasement) CFM portfolios were yielding about 1.6% at that time. That equates to a nearly 2% per year return advantage. Still think that CFM is a drag on performance?

• U.S. inflation remains elevated. A CFM portfolio is the perfect pension inflation hedge since it is fully funding liabilities that have inflation in the projected benefits to be funded.

• The direction of U.S. rates is uncertain, although rates have been trending higher, putting more strain on core fixed income strategies that tend to underperform when rates rise.

• For the 28-years prior to the bond bull market (1953-1981), U.S. rates rose. Are we in a secular long-term rising rate environment?

• Bonds should only be used for their cash flows of interest and principal upon maturity, which can be modeled to match and FUND a pension plan's liabilities (benefits and expenses), with certainty barring any defaults.

Plan sponsors have not had this level of U.S. interest rates in roughly 20-years, providing them with a wonderful opportunity to protect the improved funded status, while securing the liquidity necessary to meet those pesky monthly obligations. Will this opportunity go unheeded just as the one presented in 2000 did? We know that failing to protect and preserve DB plans in 2000 was followed by two major equity market corrections that crushed pension funding and caused contributions to skyrocket. Do you think that sponsors of DB plans have the financial wherewithal to see contributions escalate once more? I don't!

We recommend converting your current core fixed income allocation, with all of its interest rate risk, to a cash flow matching bond portfolio, that will carefully match and fund all of the monthly obligations as they come due. A CFM portfolio matches interest and principal against future obligations, and in doing so, eliminates interest rate risk as future values are not interest rate sensitive. If you owe a plan participant $2,000 in benefits next month, it is $2k whether interest rates are at 2% or 10%. The higher rates reduce the future value cost of the promised benefits in present value $s. We are seeing roughly 6% YTMs in our recent 30-year assignments and a >50% reduction in the cost of those future benefit payments.

You could continue to use a core fixed income allocation with all of its uncertainty or you could create certainty within a portion of your plan that doesn't exist today. I suspect that your participants would appreciate knowing that the promised benefits are secure no matter what transpires in global markets.

Will Rising Rates Rattle Equity Markets?

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

Uncertainty abounds! That uncertainty continues to drive expectations for oil, inflation, and interest rates up and down like a Yoyo. However, recent inflationary trends suggest that U.S. interest rates could continue higher. The U.S. 30-year Treasury bond's yield is only 4 basis points off it's cyclical peak since rates began rising aggressively in March 2022.

At Ryan ALM, we recently completed a cash flow matching (CFM) analysis for a public fund in which we were able to defease the pension plan's liabilities out to 2100. The portfolio that we created to accomplish that objective had a YTM of 6.03%. Barring any defaults (occur at <0.2% in IG space), that is what the plan sponsor should expect to receive over the life of the program. Unlike a broadly diversified pension asset allocation striving to hit an ROA target and all of its standard deviation, there is NO volatility associated with that long-term return and cash flows. There is no potential for a major drawdown impacting future contributions and the plan's funded status.

Just how has the bond market changed? This morning, our head trader, Steve Devito, shared with us the characteristics for a couple of bonds that had been shown to him. Here is an incredible example of where rates have gone: $2mm par value of ORCL 6.70 maturing in 2056 @ +245 above the comparable Treasury offered at a 7.70% YTM (quality:Baa2 / BBB-). WOW! Here you have an investment-grade corporate bond trading at a yield of 7.7%. The average ROA for a public pension plan is roughly 6.75%. In another example, Steve shared: $2mm GOOGL 6.50 maturing in 2066 @ +124 above the comparable Treasury at a YTM of 6.50% AA (40-year maturity). Google is offering a AA credit 40-year bond at a YTM of 6.5%!

I suspect that there are many other examples of high quality corporate bonds trading at yields greater than 6%. So, I ask: At what level of rates do U.S. corporate bonds become too much competition for U.S. equities and all their uncertainty? As a pension plan sponsor, wouldn't you prefer to have the certainty of a CFM portfolio securing your pension liabilities from next month chronologically as far into the future as your allocation goes? In the meantime, your residual alpha assets have just been granted a longer investing horizon allowing them to wade through today's uncertainty without being encumbered with a cash sweep of dividends and capital distributions.

As we regularly write, we are always willing to showcase how CFM can positively impact your plan by providing a free analysis. You will get a better understanding of your plan's cash flow requirements and an understanding of the potential cost reduction of the future benefit payments. You'll also have a greater appreciation for the possible significant reduction in asset management fees that is achieved through the use of CFM. Now is the time to act before the markets negatively react to these rising U.S. interest rates.

DB Pension Plans: Only One Certainty

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

As you look at the landscape for defined benefit pension plans, it is readily apparent that there is only one CERTAINTY. Each month your fund must fulfill a promise. Benefit payments (and expenses) can't wait to be paid. Like clockwork, B&E come due each month whether markets have behaved or suddenly made finding liquidity a challenge. What have you done to make sure that those obligations are met?

Pension plan management is primarily focused on the fund's assets. Sponsors and their advisors put together an asset allocation framework that is singularly focused on the annual required return on assets (ROA). But those asset allocation frameworks come with a lot of volatility and uncertainty. Many factors contribute to market movements. Each one out of the control of the pension sponsor.

Do you know where stocks will be trading in 1-hour let alone 1-month, 1-year, or 1-decade? How about inflation? Interest rates? What about the Middle East, Ukraine, China, etc.? Why live with such uncertainty?

How comforting would it be to know what a pension fund's annual contributions will be for the next 10-, 20- or 30+-years? No guessing, no budgeting woes, and no unfortunate spikes in annual contributions for public systems that harm one’s ability to support the social safety net. The process that can create this level of certainty has been used for decades: Cash Flow Matching (CFM).

As previously mentioned, current pension management approaches are return focused, which only guarantees volatility. Volatility in returns, contributions, and funded status! A CFM approach, which is the careful matching of asset cash flows (principal and interest) with the liability cash flows of benefits and expenses, will bring certainty (outside of a rare IG default) to the management of DB pensions. Importantly, liquidity is created and available when needed. There is no forced selling to fulfill those commitments. No scraping of dividend income which is detrimental to the long-term success of the equity program.

Importantly, a CFM program also "buys time" for the residual assets (presumably the alpha assets) to grow unencumbered with the goal to meet future liabilities. A longer investing horizon will dramatically enhance the probability of those assets meeting long-term return expectations.

Given that there is currently only one certainty (monthly obligations) for sponsors of DB pension plans, wouldn't it be beneficial to create another level of certainty through the SECURING of the monthly promises? Why wait, especially given all the uncertainty facing market participants today? Ryan ALM, Inc. is always willing to provide you with a free analysis of what CFM could do for your fund. We're ready to help you sleep better at night.