June 30, 2013


Over the past five years, like a playlist on repeat, Asset/Liability Watch has been reporting a downward trend in pension funding. At the onset of 2013, it looked as if the tide might be turning. By the end of the First Quarter, it definitively did. RL PPA funding had risen by six percentage points, from 67% on 12/31/12 to 73% on 3/31/31. As we are now at the half way point through the year, Q1 has repeated itself. Pension funding is up another 6% on the quarter, with a YTD funding improvement of 12 percentage points for a traditional asset allocation, rising from 67% to 79% on a RL PPA mark-tomarket basis. This is a meaningful uptick in pension funding that while arguably is not driven by fundamentals, must not be ignored.


The traditional asset allocation has outperformed RL PPA liabilities by 16.32% YTD. The S&P 500 has led the way with a 12.63% YTD return, while PPA liabilities have declined in value by –9.28%. The asset allocation model return of 7.03% has led to such a meaningful outperformance of assets versus liabilities. While asset allocation returns stagnated over the past quarter at +0.85%, assets still outperformed liabilities by +7.55%. The RL PPA Index, with a liability duration of 14.03 years and priced on an equal weighted basis, widened by 58 basis points YTD, going from 3.22% to 3.80%.


Page 3 of Asset/Liability Watch tracks pension funding on an annual basis going back to 2000. When looking at this table, two data points jump out. First, the majority of funding ratios are in red, i.e., underfunded. Second, there is a significant range of funding ratios on this page, starting at 145% funded in 2000 as the high, and 66% funded as the low in 2011, i.e., extremely volatile. As quickly as funding improved by 12%, these gains may disappear in the next six months. Alternatively, this rally can continue or funding improvements can plateau at current levels.


As we’ve seen over these past 10 years, when volatility happens, it happens fast, and there is very little time to react. Once volatility begins, plan sponsors with traditional asset-only strategies have left themselves exposed to be pushed and pulled in whatever direction the markets decide to move. In any other area of corporate or public finance, hoping for a positive outcome versus strategically assessing probabilities of outcomes and making sure they fall within tolerable risk constraints would put a public or private entity at greater risk, strategically and as a fiduciary. If a plan sponsor has a plan in place prior to volatility, only then can the be proactive and increase the probability of successfully derisking their pension plan.


As funding has improved dramatically in the past 6 months, the June 30, 2013 Asset/Liability Watch hopes to serve as a strong reminder to take a moment to review your strategic and tactical asset allocation goals and objectives. While we are pleased with the strong performance asset returns and negative liability returns, history has shown what happens when maintaining traditional exposure to performance assets. Whether it’s nominal, meaningful, or full derisking, strong performance returns and higher yields make a compelling argument to do to preserve funding ratio improvements.