Asset Allocation

US funds need paradigm asset allocation shift

US public pension funds are ignoring their liabilities in managing their pension assets, a situation that needs a paradigm shift in thinking and asset allocation to ensure benefits can be paid to beneficiaries.

The dialogue about the US public pension funds’ underfunding position continued at the CFA Institute’s annual conference this week, with Ronald Ryan calling for pension funds to tell the “financial truth”.

Ryan, who is chief executive and founder at Ryan ALM, Inc., which specialises in custom liability indices and liability beta portfolios, says the accounting rules governing US corporate and public funds are distorting the real underfunding position, which is much worse than reported.

Further, he says pension funds tend not to manage to liabilities, a situation which means “you don’t know the enemy”.

“Given the enormity of the pension crisis, investment consultants and those managing the pension assets need to say what we have been doing doesn’t work. It’s simple – tell the financial truth,” he says. “Imagine a doctor getting an X-ray or blood test wrong, well that’s what’s happening in pensions, it’s getting the wrong diagnosis. Without a customised liability index you don‘t know the enemy, you don’t know what liabilities look like. But they are big and they are very interest rate sensitive.”

Ryan says there needs to be a paradigm shift in the asset allocation of the US pension system so that liabilities can be funded in a stable and low cost way.

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He advocates for each fund to have a custom-liability index, which sets out the benefit schedule which can be priced at market rates and the size, shape, duration and interest rate sensitivity of liabilities can be managed.

“At every investment meeting of a pension fund you would think there would be a discussion of the funded ratio to gauge if they are on track and how to make sure the asset allocation responsive to liabilities. But this doesn’t happen,” he says.

Ryan, who was also formerly director of fixed-income research at Lehman Brothers and has received a number of awards, including the Bernstein Fabozzi/Jacobs Levy outstanding article award from the Journal of Portfolio Management and the William F. Sharpe Indexing Achievement Award for lifetime achievement from the Information Management Network, also advocates for a change in the language around pension management.

“Once liabilities are defined as the true objective, we have to redefine the language used. For example alpha will no longer be excess asset growth, but the amount above liabilities growth.”

One of the problems he identifies is that change will involve the players in the industry recognising they got it wrong.

“Consultants find it hard to say all these years we’ve been doing it wrong and now I want to do it differently,” he says.


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