LMP-1: P&I article on corporate & public pension plans

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grok87
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LMP-1: P&I article on corporate & public pension plans

Postby grok87 » Thu Apr 20, 2017 8:40 pm

LMP-1: P&I article on corporate & public pension plans

LMP = Liability Matching Portfolio

This article from Pensions & Investments magazine discusses the diverging investment strategies of corporate pension plans vs public (ie municipal) pension plans.

http://m.pionline.com/article/20170417/ ... going-up/W

...
"Split on bonds: Corporate plans have increased their bond allocations as more have adopted LDI strategies, while public plans have lowered bond allocations, as the need for returns has led them to riskier asset classes."
...
note: LDI = Liability Driven Investments = LMP

So first of all, why should you care even if you don't have a defined benefit pension?

Well these pension plans have the same aim as us- to figure out how to invest to fund people's retirements. But they are going in different directions:

Corporate plans are choosing to adopt more of a liability matching portfolio (LMP) approach. They are buying more long term bonds, maybe buying inflation protection if those pensions have COLAs etc.
Bonds generally have lower expected returns but corporations are willing to live with that as they don't want the risk of their pension plans showing up at a bad time and messing up their quarterly earnings.

Municipal plans are going the other way, doing less liability matching investing (bonds) and investing more in equities and alternatives.

So what's your retirement investing strategy?

Are you doing more LMP like the corporate pension plans? Or taking more risk like the municipal pension plans? Or staying the course?
Frodo: I wish it need'nt have happened in my time. Gandalf: So do all who live to see such times. But that isn't for them to decide. All we have to decide is what to do with the time that is given us.

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Re: LMP-1: P&I article on corporate & public pension plans

Postby Grt2bOutdoors » Thu Apr 20, 2017 8:47 pm

Staying the course. I am not willing to take more risk for questionable returns. There is saying "more money has been lost reaching for yield than at point of a gun" - insert "return" for yield. The public pension funds find themselves between a rock and a hard place, they should have thought about before they signed those contracts.
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Re: LMP-1: P&I article on corporate & public pension plans

Postby Angst » Thu Apr 20, 2017 9:33 pm

Gee... well, bonds are generally for safety, and equity is for risk, and hopefully return. One is safe and conservative, and one is risky and aggressive. Personally, I go for 15% of this, and 85% of that, thank you... but as far as my pension goes, I just want the result, i.e. the guarantee. I'd prefer to see my employer investing in bonds, not equity. But they want to make the math work.

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Doc
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Re: LMP-1: P&I article on corporate & public pension plans

Postby Doc » Fri Apr 21, 2017 6:37 am

Angst wrote:Gee... well, bonds are generally for safety, and equity is for risk, and hopefully return. One is safe and conservative, and one is risky and aggressive. Personally, I go for 15% of this, and 85% of that, thank you... but as far as my pension goes, I just want the result, i.e. the guarantee. I'd prefer to see my employer investing in bonds, not equity. But they want to make the math work.

If a corporate pension plan needs added contributions the company will put in more money to keep it solvent. The public pension plan is more likely to cut benefits. Employee's morale vs taxpayers rath.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

grok87
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Re: LMP-1: P&I article on corporate & public pension plans

Postby grok87 » Fri Apr 21, 2017 7:17 am

Grt2bOutdoors wrote:Staying the course. I am not willing to take more risk for questionable returns. There is saying "more money has been lost reaching for yield than at point of a gun" - insert "return" for yield. The public pension funds find themselves between a rock and a hard place, they should have thought about before they signed those contracts.


Thanks.
For me it's always a balance between ability, need and willingness to take risk.
I'm aiming to replace 40% of my current income wirh a LMP of social security, long-term tips and i-bonds.
The rest is in a Swensen-like risk portfolio (RP) of 50% equities, 25% real-estate/Alts, 25% intermediate treasuries.
Frodo: I wish it need'nt have happened in my time. Gandalf: So do all who live to see such times. But that isn't for them to decide. All we have to decide is what to do with the time that is given us.

grok87
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Re: LMP-1: P&I article on corporate & public pension plans

Postby grok87 » Sat Apr 22, 2017 7:25 am

Angst wrote:Gee... well, bonds are generally for safety, and equity is for risk, and hopefully return. One is safe and conservative, and one is risky and aggressive. Personally, I go for 15% of this, and 85% of that, thank you... but as far as my pension goes, I just want the result, i.e. the guarantee. I'd prefer to see my employer investing in bonds, not equity. But they want to make the math work.


You're lucky to have a pension. I'm basically trying to recreate that with my liability matching portfolio strategy (LMP).
Frodo: I wish it need'nt have happened in my time. Gandalf: So do all who live to see such times. But that isn't for them to decide. All we have to decide is what to do with the time that is given us.

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Re: LMP-1: P&I article on corporate & public pension plans

Postby Angst » Sat Apr 22, 2017 7:37 am

grok87 wrote:You're lucky to have a pension. I'm basically trying to recreate that with my liability matching portfolio strategy (LMP).

It's small - SS is more significant for me, but I'll take what I can get. And between the two of them, and my small (but still growing) LMP built mostly with 30 year TIPS, my expected minimum expenses will be covered. As such, I'm dedicating most (about 85%) of my portfolio to equity, largely SCV.

grok87
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Re: LMP-1: P&I article on corporate & public pension plans

Postby grok87 » Sat Apr 22, 2017 7:52 am

Angst wrote:
grok87 wrote:You're lucky to have a pension. I'm basically trying to recreate that with my liability matching portfolio strategy (LMP).

It's small - SS is more significant for me, but I'll take what I can get. And between the two of them, and my small (but still growing) LMP built mostly with 30 year TIPS, my expected minimum expenses will be covered. As such, I'm dedicating most (about 85%) of my portfolio to equity, largely SCV.

THat makes a lot of sense to me.

Re the SCV, So i used to tilt heavily to Small cap value as well. But William Bernstein's book on "Deep Risk" caused me to rethink that a bit. My belief is that small cap value should do well in times of unexpected inflation but perhaps do poorly in a depression/deflation scenario. (ken french's dataset seems to show this is what happened in the 30s and 70s for example.)

So i decided that with my SCV tilt and TIPS i was well positioned for a stagflation scenario but less well positioned for depression/deflation scenario.
These days my stocks are mostly in Total Stock market and total international stock market. If i had the tax-advantaged space i would tilt more to the vanguard minimum volatility fund (VMNVX) which i believe invests in less leveraged companies that would perhaps do better in a deflation scenario.

cheers,
grok
Frodo: I wish it need'nt have happened in my time. Gandalf: So do all who live to see such times. But that isn't for them to decide. All we have to decide is what to do with the time that is given us.

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Re: LMP-1: P&I article on corporate & public pension plans

Postby peppers » Sat Apr 22, 2017 8:25 am

We will have one corporate pension and one public pension. Currently the corporate pension gets a one percent annual increase and the public pension gets a three percent annual increase. Our retirement portfolio is about 45/55 equity to fixed income with contributions going 50/50 into total stock market fund and intermediate investment grade bond fund. We are still working and will claim SS at some point. Our ages are 65 and 63.
"..the cavalry ain't comin' kid, you're on your own..."

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Re: LMP-1: P&I article on corporate & public pension plans

Postby Angst » Sat Apr 22, 2017 8:56 am

^Thank you grok. I appreciate your insight very much as the extent of my SCV tilt is still a work in progress, especially given that I have the luxury of still being in the workforce and adding to savings and steering contributions here or there. I'm trying to settle in on the right balance btw TSM (both US & INTL) and SCV - i.e., something I feel is both rational and something I'm ready to stick with. The best part of it all though is that floor comprised of SS, pension and the TIPS LMP. It's my rock, my foundation. :happy

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Re: LMP-1: P&I article on corporate & public pension plans

Postby grok87 » Sat Apr 22, 2017 6:38 pm

Doc wrote:
Angst wrote:Gee... well, bonds are generally for safety, and equity is for risk, and hopefully return. One is safe and conservative, and one is risky and aggressive. Personally, I go for 15% of this, and 85% of that, thank you... but as far as my pension goes, I just want the result, i.e. the guarantee. I'd prefer to see my employer investing in bonds, not equity. But they want to make the math work.

If a corporate pension plan needs added contributions the company will put in more money to keep it solvent. The public pension plan is more likely to cut benefits. Employee's morale vs taxpayers rath.

Good point.

the lesson for me is that we as individual investors saving for retirement are more like corporate pension plans. faced with having to make up shortfalls out of future earnings that may or may not be there, the rational thing is to favor liability matching strategies (LMP).
Frodo: I wish it need'nt have happened in my time. Gandalf: So do all who live to see such times. But that isn't for them to decide. All we have to decide is what to do with the time that is given us.

grok87
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Re: LMP-1: P&I article on corporate & public pension plans

Postby grok87 » Sun Apr 23, 2017 3:51 pm

peppers wrote:We will have one corporate pension and one public pension. Currently the corporate pension gets a one percent annual increase and the public pension gets a three percent annual increase. Our retirement portfolio is about 45/55 equity to fixed income with contributions going 50/50 into total stock market fund and intermediate investment grade bond fund. We are still working and will claim SS at some point. Our ages are 65 and 63.

thanks

you are lucky to have pensions. My liability matching portfolio is aimed at replicating a pension since i don't have one.
Frodo: I wish it need'nt have happened in my time. Gandalf: So do all who live to see such times. But that isn't for them to decide. All we have to decide is what to do with the time that is given us.

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Re: LMP-1: P&I article on corporate & public pension plans

Postby bobcat2 » Sun Apr 23, 2017 5:15 pm

grok87 wrote:LMP-1: P&I article on corporate & public pension plans

LMP = Liability Matching Portfolio

Split on bonds: Corporate plans have increased their bond allocations as more have adopted LDI strategies, while public plans have lowered bond allocations, as the need for returns has led them to riskier asset classes.

note: LDI = Liability Driven Investments = LMP


note: LDI LMP
While they have some similarities, LDI and LMP are not the same. Basically, LMP is a limited subset of LDI.

Here are some differences. LDI, as noted in the quote, is an investing strategy, not a portfolio. In an LDI strategy the investor as they approach retirement and during retirement duration matches at least part of the portfolio's assets to the duration of the liabilities in order to hedge interest rate risk. Pensions following an LDI strategy also duration match as do insurance companies when funding life annuities. These days pension funds often hedge interest rate risk not only with duration matching, but also with derivative contracts, often using swaps.

Rarely does someone advocating using an LMP duration match. For instance I have never read anything by William Bernstein, the chief proponent of LMP, where he duration matches assets to liabilities prior to retirement. See the following quote and linked article by Bernstein where he discusses LMP.
A more prudent course of action might be to hold standard Treasury securities and high-quality municipal and corporate bonds of short maturity in lieu of purchasing either an annuity or TIPS.

Link - https://www.wsj.com/articles/how-to-think-about-risk-in-retirement-1417408070

No one following an LDI strategy would use use short-term bonds to fund a long-term liability, regardless of whether interest rates are currently low or not. The duration mismatch of such an approach negates the safety of the approach.

At best LMP is a crippled limited offspring of general liability driven investing strategies.

BobK
Last edited by bobcat2 on Sun Apr 23, 2017 5:20 pm, edited 1 time in total.
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: LMP-1: P&I article on corporate & public pension plans

Postby Doc » Sun Apr 23, 2017 5:20 pm

grok87 wrote:My liability matching portfolio is aimed at replicating a pension since i don't have one

I always wondered why you would want to fund a 30 yr LMP with real yields at rock bottom instead of taking more risk until yields improved. Now I know. :sharebeer
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Re: LMP-1: P&I article on corporate & public pension plans

Postby bobcat2 » Sun Apr 23, 2017 5:35 pm

Another key difference between LDI and LMP is that LDI strategies, whether public pensions, corporate pensions, or an individual planning retirement by allocating assets in a DC plan, use the funded ratio as a key metric. OTOH when people advocate developing an LMP, the funded ratio is at best an after thought. For example, in William Bernstein's book about life-cycle finance, The Ages of the Investor: A Critical Look at Life-cycle Investing, LMP is discussed at length, but I can't find one mention of the funded ratio.

Compare Bernstein's not mentioning the funded ratio with the following table by Robert Merton, an advocate of LDI retirement strategies for individuals. As you can see from the table, the goal-based retirement strategy Merton favors (an LDI strategy) emphasizes the funding ratio metric in driving the entire investment strategy.

Goal Based Investing focused on what matters most: Income

Investments

Code: Select all

Planning Process                      Conventional Retirement               Goal-Based Retirement                                                       
                                                                     
Investment Goal                      Wealth accumulation                    Retirement Income
                                     (No specified wealth Goal)             (Specified desired income goal)

Risk Measure                         Volatility of portfolio returns        Volatility of funded ratio(FR) 

Success Measure                      Account balance size                   FR relative to income goal

Asset allocation strategy            Generic Fixed or age-only              Dynamic based on age,income & FR-focused                                                                              on improving FR                 


This again gets back to duration matching, because maximizing the probability of a funded ratio of 1.00 or greater at retirement and during retirement involves duration matching.

BobK
Last edited by bobcat2 on Sun Apr 23, 2017 6:03 pm, edited 2 times in total.
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

grok87
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Re: LMP-1: P&I article on corporate & public pension plans

Postby grok87 » Sun Apr 23, 2017 5:49 pm

Doc wrote:
grok87 wrote:My liability matching portfolio is aimed at replicating a pension since i don't have one

I always wondered why you would want to fund a 30 yr LMP with real yields at rock bottom instead of taking more risk until yields improved. Now I know. :sharebeer

thanks
:sharebeer
Frodo: I wish it need'nt have happened in my time. Gandalf: So do all who live to see such times. But that isn't for them to decide. All we have to decide is what to do with the time that is given us.

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Re: LMP-1: P&I article on corporate & public pension plans

Postby grok87 » Sun Apr 23, 2017 6:18 pm

bobcat2 wrote:
Rarely does someone advocating using an LMP duration match. For instance I have never read anything by William Bernstein, the chief proponent of LMP, where he duration matches assets to liabilities prior to retirement. See the following quote and linked article by Bernstein where he discusses LMP.
A more prudent course of action might be to hold standard Treasury securities and high-quality municipal and corporate bonds of short maturity in lieu of purchasing either an annuity or TIPS.

Link - https://www.wsj.com/articles/how-to-think-about-risk-in-retirement-1417408070

No one following an LDI strategy would use use short-term bonds to fund a long-term liability, regardless of whether interest rates are currently low or not. The duration mismatch of such an approach negates the safety of the approach.


Thanks Bob.
I guess this is the quote i focus on from the article
William Bernstein wrote:The key point is that all three choices—an inflation-adjusted annuity, TIPS ladder or short-bond portfolio—or any combination of them would match the retiree’s annual needs well, because they all provide a known stream of income and principal over the years. A portfolio starting at 60% bonds and 40% stocks with a subsequent glide path away from equities most certainly doesn’t provide that assurance.


I think you have a good point. William Bernstein doesn't mention, if one goes with the TIPs ladder approach, over what time frame one might build it. I wonder if we could get him to chime in here somehow?

He does seem to suggest, as you state, that he is not enthusiastic about purchasing either a inflation adjusted annuity or a TIPS ladder right now with interest rates so low (although the article was written in 2014 and rates are fractionally higher now). But i wonder if he might be sympathetic to the approach i follow and advocate- purchasing the TIPS ladder gradually over say a 20 or 30 year period- buying one rung each year as it were?
That way you are mitigating the risk of buying at a bad time.

cheers,
grok
Frodo: I wish it need'nt have happened in my time. Gandalf: So do all who live to see such times. But that isn't for them to decide. All we have to decide is what to do with the time that is given us.

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Re: LMP-1: P&I article on corporate & public pension plans

Postby learning_head » Mon Apr 24, 2017 12:58 pm

William Bernstein wrote:The key point is that all three choices—an inflation-adjusted annuity, TIPS ladder or short-bond portfolio—or any combination of them would match the retiree’s annual needs well, because they all provide a known stream of income and principal over the years. A portfolio starting at 60% bonds and 40% stocks with a subsequent glide path away from equities most certainly doesn’t provide that assurance.


Bill Bernstein highlights COLA-d annuity company risk and TIPS ladder reinvestment risk (as well as need for large tax-advantaged space), but I did not know he believes short-bond portfolio of "high-quality municipal and corporate bonds" provides assurance of inflation-protection that is very close to those two, while saying 60/40 portfolio does not.

It certainly seems much easier to invest in short-term AAA corporate bonds than bother with TIPS ladders or give up annuity premium. Does it really provide nearly as much assurance of the real income stream though?! I would not have thought so. Real income of TIPS is assured by US government. Real income of COLA-d annuities are assured by insurance company + state guarantee association. What assures real income of short term corp bond funds? Are the guarantees of purchasing power protection really similar in this case?

Perhaps what he means is that while risks of company failure + state guarantee failure for annuities and reinvestment risks for TIPS are different, they are comparable in their risks with short term AAA bond investments neither being guaranteed nor keeping up with same level of inflation protection? Further, 60/40 portfolio has much less ability (i.e. much more risk) in providing that level of inflation protection?

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Re: LMP-1: P&I article on corporate & public pension plans

Postby bobcat2 » Mon Apr 24, 2017 2:36 pm

learning_head wrote:
William Bernstein wrote:The key point is that all three choices—an inflation-adjusted annuity, TIPS ladder or short-bond portfolio—or any combination of them would match the retiree’s annual needs well, because they all provide a known stream of income and principal over the years.


It certainly seems much easier to invest in short-term AAA corporate bonds than bother with TIPS ladders or give up annuity premium. Does it really provide nearly as much assurance of the real income stream though?! I would not have thought so. Real income of TIPS is assured by US government. Real income of COLA-d annuities are assured by insurance company + state guarantee association. What assures real income of short term corp bond funds? Are the guarantees of purchasing power protection really similar in this case?


What assures real income of short term corp bond funds?
Nothing.

Are the guarantees of purchasing power protection really similar in this case?
No.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.


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