September 30, 2014
Like a rising crescendo of the New York Philharmonic Orchestra, tension is building in both the capital markets and in pension funding. With QTD returns of the Ryan Labs Asset Allocation Model grinding to a halt, the ingredients for a pullback are permeating the equity markets. Similarly, liability returns are approaching double digits for the year. This combination has already seen pension funding ratios decline from year-end 2013. Now the only question is will this trend continue through the end of 2014?
The RL Asset Allocation Model has returned +5.26% YTD, an increase of only 0.03% from the end of Q2. The S&P is up +6.71%, and the Barclays Aggregate is up +4.10%. On the right side of the asset/liability spectrum, The RL PPA (Pension Protection Act) yield is down from a 2013 year end 3.83% YTW to 3.41% as of 9/30/14. This 42 bps of tightening has caused RL PPA liabilities return +9.09% YTD. The resulting affect on funding ratios have seen RL PPA funding decline from 85% as of 12/31/13 to 82% at 9/30/14, a +1% improvement from the end of Q2.
Two short years ago, the RL PPA funding ratio was at 67%. From 2007 to 2008, funding ratios declined -32%. From 2001 to 2002, funding ratios declined by -36%. While there are differences between the credit crisis, the dotcom crash, and the current economic environment, there is a key common denominator that has shown time and time again to be true. “What the market giveth, the market can taketh away.” In times of volatility, fear, and uncertainty, especially when this environment exists after a +18% gain in funding ratios (2012 to 2013, +16% from 2012 to 9/30/14), cautious conservatism in an asset allocation model could prove to be highly advantageous in preserving funding gains for pension plans.
Page 3 serves as a prescient warning of what happens when asset allocations do not proactively derisk as funding ratios improve...funding ratios resultantly tend to decline. Regardless of whether a plan is duration matched or not, strategically or tactically oriented, balance sheet rich or poor, or interest rates are high or low, leaving your asset allocation static regardless of plan funding ratios will inevitably lead to funding ratio volatility to a meaningful degree.
While “glide path” has become standardized terminology to describe the act of increasing fixed income as funding ratios increase in order to reduce surplus volatility, the act of moving along a glide path is not as standardized. There is still room to take in account risk capacity and risk budgeting. The applicability of glide path implementation is the same for an ongoing plan or one that is looking to terminate, one that is frozen or open. Regardless of your pension plan’s status and future objective the glide path’s purpose is to increase the