Products April 9, 2018

Bond Manager Reflects on Industry Change, Increased Role of LDI

The president and CIO of Ryan Labs describes in detail the mechanics behind the firm’s new defensive bond portfolio strategy—and the way his work continues to be shaped by the Pension Protection Act and MAP-21.

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Richard Familetti was last year appointed president and chief investment officer of Ryan Labs, a Sun Life Investment Management Company specializing in bond portfolios, following his initial 2009 hire as senior portfolio manager and a 2012 promotion to head of asset management.

Sitting down for a high-level strategy discussion with PLANADVISER, Familetti suggested his firm is set apart by the long tenure of its investment management team.  

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“When I first joined Ryan Labs, I was very impressed to see the portfolio management team has been made up of the same core group of professionals, plus some additions, for the entire history of the firm, going back to our real entry into the asset management space in 2004,” he noted. “Prior to that time, we were more of an advice and data provider. We have had the opportunity to really evolve and flourish post Pension Protection Act.”

The asset management group stated by offering a single core fixed-income strategy, Familetti noted, but over time the liability-driven investing (LDI) capabilities have really ramped up. This has been fueled by the cumulative impact of the PPA, as well as the Moving Ahead for Progress in the 21st Century Act (MAP-21) and its successors, the Highway and Transportation Funding Act of 2014 (HATFA) and the Bipartisan Budget Act of 2015. Familetti also pointed to the recent tax cuts and rapidly growing Pension Benefit Guaranty Corporation (PBGC) premiums as key motivators of pension plan sponsor de-risking behavior.

“With all of this going on in the background, the fixed-income side of the pension plan portfolio is really thought of differently today than in the past, and this has had a pretty big impact on our firm over time,” Familetti explained. “Today we have a full suite of investment grade fixed-income offerings, including short-duration enhanced strategies, core fixed-income offerings, and long duration portfolios—either offered as a custom product or against a Barclay’s benchmark.”

At this stage, Familetti estimated about half his firm’s total invested assets are directed particularly at LDI programming and pension liability management—whether tied to a Barclay’s benchmark or to a custom benchmark. The other half is made up of core and/or short-duration holdings for clients, he explained.

Role of the consultant remains strong

Another change that has occurred over time is the increasingly prominent role of investment consultants in helping to shape LDI strategies and other pension plan behaviors.

“We always are asked by investment consultants about our retention strategies for our management team. Funny enough, they always ask first about the money,” Familetti observed. “They want to know, what is the structure of the deferred compensation and the equity earned by our team? But we’ve demonstrated time and again that manager success is about more than just compensation. It is important for folks in this field to like to work together and to really enjoy what they do. It sounds cheesy, I know, but it is true.”

Familetti further observed that there “have simply been many more consultants and clients who have become focused on long-duration and LDI hedging strategies.” Increasingly they are using “benchmarks where they change allocations dynamically, in both directions, according to interest rates and the level of equities—as opposed to just moving in response to a didactic idea that you want to buy all the bonds you can to eliminate equity risk.”

“That has been the story behind most of the business we have seen recently,” Familetti explained. “Consultants will have different views in terms of how we, as the manager, fit into this effort. When it comes to small and medium-sized pension funds, oftentimes we are working very closely with a consultant to come up with a bond portfolio and a mix of equities that makes sense for that client. It has become very collaborative, in that respect.”

While pension plans are, broadly speaking, on the decline, Familetti expects the role of the consultant in serving this marketplace will remain strong for some time.

“We know that pension plan sponsors have a lot of responsibilities, and unless they are a finance professional in their own right, it may be difficult for them to dig into the weeds on the fixed-income side of the portfolio—or even the equity side of things,” he said. “So there is a lasting reliance on the consultant and their expertise. We meet with so many consultants, and the depth of their due diligence today is amazing. We find ourselves working with all different types of consultants these days.”

Tied to the broad LDI trend and the push towards de-risking, another trend Familetti has observed on the part of investment consultants is “a real push towards more dynamic strategies that are proactive about rebalancing the equity/fixed income mix as interest rates move slowly back towards normal.”

It was with this trend in mind that the firm conceived and launched its latest strategy, dubbed the “Defensive Risk Premia (DRP) strategy.” The portfolio solution is designed for corporate and public pension plans, as well as other institutional investors, Familetti explained.

“This strategy is designed to enhance the defensive role the fixed income allocation plays within the total asset allocation of an institutional investor’s portfolio and to further offset losses from equity market downturns,” he said. “Using a proprietary quantitative model that monitors financial and economic risk on a daily basis, the DRP strategy is designed to turn on when elevated equity risk is indicated and there is a flight to quality into safe haven assets. Using treasury futures contracts, the strategy aims to dynamically offset negative equity performance of market volatility.” 

Offering some additional context, Familetti pointed out that the strategy focuses on three key volatility variables, “not just the VIX.”

“Importantly, it is off all the time, until it is switched on. And then it is only on for a short period, by design, in the context of sharp market drawdowns, which are usually by their nature short-lived and aggressive,” he said. “Once our three risk sign posts turn on, we in effect start to buy long-term treasury futures as a short-term hedge against equity drawdowns. Interestingly, the strategy has only been turned on once in the last year or so—the recent volatility spike hasn’t actually triggered it. And this makes sense, because equity markets have stabilized quite quickly, so we saw just one of the risk signals turn on, but not the others.”

Compliance April 6, 2018

Ruling on NY Times Multiemployer Plan Arbitration Challenge Rejects Use of ‘Segal Blend’

Following extensively detailed deliberation citing important SCOTUS rulings and other precedents, the district court ruling rejects a multiemployer plan’s usage of the so-called “Segal Blend” to set the discount rate for assessing a member's withdrawal liability.

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The U.S. District Court for the Southern District of New York has ruled in a complicated dispute involving a carefully negotiated multiemployer collective bargaining agreement that governs certain aspects of the Newspaper and Mail Deliverers’-Publishers’ Pension Fund, which serves many newspapers in New York City.

This decision in particular involves a challenge to the results of arbitration engaged in by the multiemployer plan and the New York Times Company—among various other issues asking whether and to what extent the Times incurred and/or properly settled withdrawal liabilities arising from its partial withdraw from the multiemployer pension fund for plan years ending May 31, 2012, and May 31, 2013.

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The ruling is technically issued on consolidated actions involving The New York Times Company, the Newspaper and Mail Deliverers’-Publishers’ Pension Fund, and the Board of Trustees of the Newspaper and Mail Deliverers’-Publishers’ Pension Fund. The parties cross-moved for summary judgment under Federal Rule of Civil Procedure 56 on their respective requests to modify or vacate an arbitration award issued by the court-assigned assigned arbitrator Mark L. Irvings in American Arbitration Association (AAA) Case No. 01-14-1433 on July 19, 2017, pursuant to the Employee Retirement Income Security Act (ERISA), as amended by the Multiemployer Pension Plan Amendment Act of 1980 (MPPAA).

In the colorfully written opinion, the district court judge notes that the instant motions “present a veritable Augean Stables of issues to be resolved, a cavalcade of sharp disputes that have been distilled down by the parties and their skilled counsel to four principal issues.”

Put simply, these issues are as follows: “(1) whether the Times incurred liability by partially withdrawing from the fund for plan years ending May 31, 2012, and May 31, 2013; (2) whether the discount rate used by the fund when assessing the Times’ withdrawal liability was appropriate; (3) whether the fund applied the proper statutory procedure to calculate liability for the second partial withdrawal; and (4) whether and to what extent the Times is entitled to interest on the repayment of overpaid withdrawal liability.”

On these issues, the U.S. District Court for the Southern District of New York has ruled first that the Times did in fact incur withdrawal liability, “and the Arbitrator’s finding that the CBA’s contribution base unit under 29 U.S.C. § 1301(a) (11) was shifts has not been rebutted.” Second, the court has ruled the fund’s “use of the Segal Blend rate when assessing the Times’ withdrawal liability was, in this instance, improper, and the Arbitrator’s finding to the contrary is reversed.” Third, the fund’s calculation of the Times’ second partial liability was ruled to be improper. Lastly, the court ruled the Arbitrator “correctly determined that the Times was entitled to interest on overpaid withdrawal liability, and [the Arbitrator’s] conclusion as to the applicable interest rate has not been rebutted.”

Perhaps the most important result for readers of PLANADVISER comes out of the second question, and the fact that the ruling rejects the multiemployer plan’s usage of the so-called “Segal Blend” to set its discount rate for paying its withdrawal liability. Historically, use of this discount rate by large multiemployer pension plans has resulted in exiting members paying larger cash amounts than they otherwise would if other methods of setting the rate were used.  

As laid out in the text of the decision, the multiemployer pension fund’s actuary, The Segal Company, after concluding that the Times had partially withdrawn from the fund, used a discount rate of 6.5%, known in the industry as the Segal Blend, which was calculated by blending the fund’s investment-return rate of 7.5% with lower, risk-free rates published by the Pension Benefit Guaranty Corporation (PBGC).

“This rate was different than what the fund used when calculating the Times’ minimum funding requirements,” the court explains. “As such, the parties dispute whether the asymmetrical application of the Segal Blend was legally permissible.”

The decision goes on: “The Times contends that the fund’s actuary’s use of the Segal Blend violated both ERISA and Supreme Court precedent. First, the Times argues that the rate the fund used for calculating minimum funding requirements, 7.5%, needed to be the same that was used for any withdrawal liability calculations. In support, the Times identifies identical language in ERISA between the minimum funding rules and withdrawal liability calculations, both of which require an actuary to use rates that are ‘reasonable (taking into account the experience of the plan and reasonable expectations)’ and which, ‘in combination, offer the actuary’s best estimate of anticipated experience under the plan.’”

Congress’ use of identical language, the Times contends, meant that the same assumptions, and, therefore, the same rates, were to be used in both cases. In addition, the Times points to the Supreme Court’s decision in Concrete Pipe & Prods. of Cal., Inc. v. Constr. Laborers Pension Tr. for S. Cal., which discussed “the necessity” of a fund actuary to apply “the same assumptions and methods in more than one context,” particularly highlighting a fund’s interest rate assumption.

Based on those statements, the Times avers that the pension fund’s actuary’s use of the Segal Blend solely for the purpose of calculating withdrawal liability was wrong. Lastly, the Times argues that the Segal Blend’s estimation was not the best estimate of the anticipated experience of the fund, because a blend of risk-free rates does not represent the fund’s actual investment portfolio.

The text of the decision includes extensively detailed consideration of this matter. Ultimately, the judge has ruled that, “in sum, the actuary’s testimony, combined with the untethered composition of the Segal Blend and paucity of analysis by the Arbitrator, create a definite and firm conviction that a mistake has been made in accepting the Segal Blend; as such, this Court will set the findings aside even though there is evidence supporting them that, by itself, would be considered substantial. … Accordingly, the Arbitrator’s decision that the Segal Blend was the appropriate rate to calculate the Times’ partial withdrawal is reversed. In the absence of additional evidence sufficient to support a different rate, the Times’ liability should be recalculated using the 7.5% assumption testified to as the best estimate.”

Segal’s Senior Vice President and General Counsel Margery Sinder Friedman shared the following statement in response to the ruling: “We view the ruling, which is limited to the jurisdiction of the US District Court for the Southern District of New York, to be an aberration from the many settled cases around the country that have diligently examined the question of what interest rate assumptions are reasonable for calculating withdrawal liability.  The Segal Blend is one common method, as are other means, to determine a settlement value when an employer leaves the plan.  In fact, the Court in this case interpreted the statute to say that the ongoing funding interest rate assumption is not the only method multiemployer pension plan actuaries can use.  We are very interested in seeing how this matter is resolved upon appeal, and plan to file a friend of the court brief seeking to reverse the decision.”

Read the full text of the decision here.

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