Problem: Pension Crisis Solution: Portable Alpha Ryan ALM, Inc. - The Solutions Company...
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Transcript of Problem: Pension Crisis Solution: Portable Alpha Ryan ALM, Inc. - The Solutions Company...
Problem: Pension CrisisSolution: Portable Alpha
Ryan ALM, Inc. - The Solutions Company1-888-RyanALM
www.ryanalm.com
2Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Index Returns YTD 2009
Estimated Weights
Liabilities : Market (Tsy STRIPS) FAS 158 (AA Corporates) PPA (3 Segment) PPA (Spot Rates) GASB /ASOP (8% ROA)
-19.52 % 12.67 4.54 23.53 8.16
100 %
Assets : Ryan Cash Lehman Aggregate S&P 500 MSCI EAFE Int’lAsset Allocation Model
0.53 % 5.9326.4632.45
5 % 30 60 5
19.43 % 100 %Assets – Liabilities Market FAS 158 PPA (3 Segment) PPA (Spot Rates) GGASB/ASOP (8% ROA)
38.95% 6.76 14.89-4.1511.27
The Ryan Letter December 2009(Copyright Ryan ALM, Inc. 2009 …All Rights Reserved)
5Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Assets vs. Liabilities Funding Ratio(Asset Allocation (30% Bonds/60% Equity/5% Int'l/5% Cash)
12/31/1988 - 12/31/2008
0.0
20.0
40.0
60.0
80.0
100.0
120.0
140.0
160.0
180.0
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
156.5
55.8
6Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Funding Ratio____________
Ratio Market Value of Assets / MV of Liabilities
Requires Custom Liability Index
1990s Most Pensions had Surpluses
Didn’t change their Asset Allocation
2000s Funding Ratios eroded by 40% to 60%
Problem Focus on ROA instead of Funding Ratio
8Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Pension Plan Objective____________________
9Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Risk ____
Tradition Volatility of Total Returns
Ryan ALM NOT Meeting the Client Objective (Uncertainty)
Objective Liability Driven
Sharpe Ratio Based on 3 month T-BillNew Ratio Based on Objective
(Information Ratio)
10Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Risk Management
________________
Tradition Reduce Volatility of Total Returns
Ryan ALMIncrease Certainity of Meeting Objective
Objective = Liability DrivenRequires Objective Index
Objective Index Custom Liability Index
11Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Problem : Liability Valuation_________________________
Single Discount Rate
Not market interest rates
(ASOP = ROA, PPA = 2 year weighted average)
Present Value calculated annually/triennially
(Months delinquent)
Liability Term Structure not transparent
(Short, Intermediate, Long, Very Long)
12Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Problem : Generic Indexes_______________________
Represent the market not client liability schedule
Generic Indexes do NOT represent clients’ true objective
Client liability schedule is unique to each client (snowflakes)
Confucius : Given Wrong Index … Get Wrong Risk/Reward
13Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Society of Actuaries (SoA)
(Principles Underlying Asset/Liability Management) October 2004
Accounting measures distort economic reality
Consistent ALM can only be achieved for Financial Objectives
Entities that focus on economic value tend to achieve their financial objectives
Entities who manage their assets based on accounting treatment end up mismatching liabilities
Translation : ALM Requires Economic Books
15Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Custom Liability Index (CLI) _______________________________
Provide a Proper Benchmark for the Asset side to function efficiently
Asset Allocation
Asset Management Performance Measurement
Create a set of Economic Books in harmony with SoA directive
Based on Market Value
Built as a Liability Index series
16
Asset Allocation________________
Should be based on “Funding Ratio”
(Market Value of Assets / MV of Liabilities)
Requires Custom Liability Index to Measure MV of Liabilities
Large Deficit = Different Asset Allocation than Small Deficit
Should be Dynamic (Tactical)
Ryan ALM, Inc.The Solutions Company
1- 888-Ryan-ALMwww.RyanALM.com
17Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Solution: Contributions____________________
Enhances Funding Ratio
Contributions are a Future Asset
Usually pay Liability Benefit Payments
CLI will be recalculated to reflect this (Net Liability)
Current Assets should fund Net Liabilities
18
Portable Alpha ________________
Transfer (Porting) of Excess Returns above Objective Index
from Alpha Portfolio(s)
to Beta Portfolio
Requires Custom Liability Index = Liability Objective
Alpha Portfolio = non-bonds to outgrow Liabilities
Beta Portfolio = bonds to match Liabilities
Ryan ALM, Inc.The Solutions Company
1- 888-Ryan-ALMwww.RyanALM.com
19Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Liability Alpha Portfolio(s) __________________________
Alpha = Excess Return above Objective
Objective = Outgrow Liabilities (Liability Index)
Beat a Market Index …but Lose to Liabilities = You Lose !
Liability Alpha = Excess Growth above Liability Growth
Requires Custom Liability Index to Measure Alpha
20Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
True Alpha __________
Requires CLI to Measure Liability Growth (Returns)
Actual Return of Alpha Portfolios 5.00% - Actual Return of Liabilities - 5.00%
------------------------------------------ -------- True Alpha 10.00%
21Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Liability Beta Portfolio ___________________
Matches Return of Objective
Pension Objective = Liability Driven
Beta = Asset / Liability Matched Portfolio
Liability Beta = Liability Index Fund
Requires Custom Liability Index
22Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Portable Alpha(Benefits)___________
As Portable Alpha Transfers Excess Returns above Liability Index
Beta Portfolio grows and grows… creating 4 Major Benefits :
1. Reduces Contribution Costs (Fully Funds Liabilities)
2. Reduces Interest Rate Risks (Hedges Liabilities)
3. Increases Funded Ratio (Client Objective)
4. Increases Certainty of Meeting Objective
24
Asset Allocation
______________
Should be based on “Funding Ratio” and “Time”
Deficit / Time (Average Life of Liabilities) = Alpha Needed
30% Deficit / 15 years = 2% per year
Larger the Deficit > Requires More Alpha
Estimated Alpha = ROA – YTM of Liabilities
ROA = 8%
YTM = 5%
Alpha E = 3%
2% / 3% = 67% allocation to Alpha
Ryan ALM, Inc.The Solutions Company
1- 888-Ryan-ALMwww.RyanALM.com
25
Ryan ALM 5-year Scenario _______________________________________
Liabilities: Interest Rates go up
30-yr U.S. Treasury = 4.50% >> 8.50%
Growth Rate = ( 5.00%) Annual
Note: Liabilities behave like long bonds
------- Annual Growth Rate -------
Assets 5% 6% 7% 8% 9%
Liabilities - 5% -5% - 5% - 5% - 5%
Alpha (Annual) 10% 11% 12% 13% 14%
Funding Ratio = 50% > 82% 89% 94% 98% 103%
= 60% > 99% 104% 109% 115% 120%
Ryan ALM, Inc.The Solutions Company
1- 888-Ryan-ALMwww.RyanALM.com
26Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Bond Management________________
Mission Best Value in Bonds = Defeasance
Match + Fund Liabilities Chronologically
Liability Index Fund (Requires CLI)
Benefits Reduces Cost (Contributions)
Reduces Risk (Interest Rate Risk)
Reduces Volatility of Funded Ratio
28Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
PIPER Study of Bond Managers____________________________
Annual Total Returns(Periods Ending 12/31/08)
5 yrs. 10 yrs.1st Quartile 4.67% 5.75%
Median 3.84% 5.22% Lehman Aggregate 4.64% 5.63%
Median Manager loses to Lehman Aggregate 1st Quartile loses to Lehman Aggregate (after fees)
30Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Problem: No Alpha in Bonds________________________
Total Returns (Periods Ending 12/31/09)
Indexes 10 yrs. 20 yrs. Lehman Aggregate 6.33% 7.01% Ryan 5-year STRIPS 7.21% 7.57% Difference - 0.88% - 0.56%
Lehman Agg Duration consistently @ 5 year Intrinsic Value of any investment = vs. Risk-Free Treasury
31Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
No Generic Index has same Cash Flow as Clients Liabilities
Lehman Aggregate(12/31/06)
1-3 years 24.58%3-5 years 30.465-7 years 27.097-10 years 08.9110+ years 08.96
Lehman Aggregate = 40% in Securitized instrumentsCash flow behavior tends to move in wrong direction
Rates go up = duration gets longerCash flow gets reduced
Cash Flow________
32Ryan ALM, Inc.
The Solutions Company1- 888-Ryan-ALM
www.RyanALM.com
Bond Index Weights _________________
Tradition Market Cap Weighted Problem Don’t Know Current Amount Outstanding Treasury + Agency = Stripped Corporates = Sunk, Put Mortgages = Prepayment Delay New Breed Equal Weights (No Skewness)
34
Performance Measurement
_______________________
Compares Assets vs. Objective
Objective = Custom Liability Index
Beta Portfolio = Liability Index Fund
Alpha Portfolios = Portfolios that Beat Liabilities
Requires CLI to Measure Alpha and Manage Beta Portfolio
Ryan ALM, Inc.The Solutions Company
1- 888-Ryan-ALMwww.RyanALM.com