Pension fund expert Ken Akoundi , CEO of Cordatius, speaks with me about how such massive portfolios are managed, the challenges they have with technology and their investment strategies.
We start with a story that should terrify anyone with financial liabilities: the prospect that they might never end...
You know, pension fund managers have a really tough job. They have to make sure that the pile of assets that they have well , they're still there year after year to pay out the retirement benefits of the former employees under their charge. They're constantly trying to ensure that they invest the money prudently to have the cash, to pay each year's group of retirees. The market volatility can play havoc with the value of those assets and interest rates can play havoc with the estimate of how big the liabilities are in today's dollars. Now there's also the question of how long each retiree will need to be paid. As our lifespans increase. So do the timeframes over which pensions need to be ready to pay out that money. Now, most pension plans, they plan for the longterm meaning 50 years or 70 years, but the longest timeframe for any pension benefit that I'm aware of is actually shocking. The US army paid a civil war, veterans pension until, now get this, 2020. That's right - during COVID. Just before the battle of Gettysburg Confederate private Mose Triplett, well, he deserted and he joined the union army. That move probably saved his life because most of his unit was killed in the battle of Gettysburg. Now, after the war ended as a veteran of the US army, he started collecting his pension. That was in 1865. Much later in his life, he married his second wife and they had a daughter. Irene. She was born in 1930. Mose died in 1938 at the age of 93, at which point his pension benefits were extended first to his wife, and, after she died, to his daughter, Irene. Irene's death in June of 2020, finally ended the U S army pension obligation to pay that s oldier's benefits - a full hundred and fifty-five years later. Now today's episode is all about what pensions can do to better manage their assets, to ensure that their beneficiaries continue receiving those benefits, even if it's 150 years l ater.Music Intro:
Hello and welcome to what's your prior, the podcast for the adaptable investor with your hosts , Damian Handzy.Damian:
My guest today is my good friend, Ken Akoundi, who was one of the co-founders of Risk Metrics. He has been a risk manager and a professional investor and a pension fund analyst. He also runs a daily news service called investor DNA, and he runs the pension fund data and technology fi rm C ordatius and there he helps lo ng-term i nvestors like pension funds. Hey Ken, how are you? Welcome to the show.Ken Akoundi:
Damian, pleasure to be here talking to you. How are you?Damian:
Ken, n ow that we're together and we're chatting, I'm doing really, really well. It has been, it's been far too long, so I figured let's just get right into it. So can you heard the intro to this episode about the 150 year payout from the US army to one of its beneficiaries? Tell me , what do you think of that? And kind of, where are we ? What's the state of the pension fund industry today, right ?Ken Akoundi:
I mean, today, if you look at a pension funds and you talk to them, they'll tell you, they view their liabilities usually as almost like a negative, like a bond where you have to pay out a coupon where the coupon is not the same every year, it increases over time. So there's a duration that's created for these cash flows. They look at a cash is looking at 17 to 18, a year equivalent to a 17 or 18 year maturity , effective maturity. But with the stories you're telling me, yes, absolutely. I think that people have to prepare especially older countries and all their states, because the problem that we're facing here are really more , much more prevalent in Europe, the liability issues. And they're going to have a better story. And Marshall Islands had a policy where you could pass your pension benefits to your children, to your grandchildren. And because it was a small island and figured they got this benefit , but effectively that's an infinite liability for the Marshall Islands. I don't know if that has changed since then, but again, another nightmare story about how you have to produce this actuarial 7% , target of 7%, approximately, and then for eternity.Damian:
Hang on, how did they choose 7%?Ken Akoundi:
Well, they put 7% because they work it backwards. If you want to be all paid up by year X, how an actuarial assumption or such and such that we need , the last person basically dying off because that's where the liability stop. Then we need this amount of money to the last day. And , they have fantasticly archaic technologies to do these calculations and the vendors that are out there to say that, well, this is an ALM asset liability matching. We need to, at 7%, now they could pick any number. These are models, right? You can pick any number you'd really want. And the picture, as I'm sure, you know, has been started at 8% . Now it's going seven now, 6 and three quarters and keep on lowering that assumption. And the other part that is remarkable: if you look at the 1990s, the public pension plans were, for the most part, fully funded. They had enough dollars to pay all their retirees in the 1990s. And then since then they've managed to create this quagmire of underfundedness. When you have Illinois, for instance, funded at 39%, that means for every dollar they owe in the future, they have 39 cents in a kitty. And then you have a state of New Jersey that just made a $5.8 billion contribution to the pension, right? These are numbers that are, you know , mind boggling . When you think about it,Damian:
The first thing that comes to mind when you mention a funding ratio like that is kind of what discounting rate are they using for their liabilities, because that can play an awfully big role in underestimating or overestimating those liabilities and therefore goes right into whether or not they're fully funded. So what's the current state of the art, because I know once upon a time, you know, they were using some really big numbers, like 8% discounting, which made future liabilities look really, really small in today's dollars. I sure hope they're not doing that today .Ken Akoundi:
Well, they use a corporate ten-year, which is very low, right? That's typically what they use or ten-year treasury depending on a corporate plan or a public plan. And also put all of that in the context of this is a very unique year. We already started June 30 was the fiscal year for many pension plans in general. And they're all clocking 20, 25% return for the last 365 days. So all of a sudden, you know, you have, and then you have look at the city of New York, new mayor, a new controller and a new board of education. The retirement system is going to have 16 new board members. And these are volunteer positions, right? These guys are either appointed or selected. And there is a riff between a concept you talk about, which are relatively sophisticated and the reality of the board and board of education for instance, of the New York city has about 250 billion across five boards. And board of education is the smallest one of the five. And he set up his own investment office, which we help set up. And it is the only one that's fully funded, right? So that's basically then start going after the very interesting existential questions and the corporate pension plans have been dealing with this. The Canadians have been dealing with this because the public plans or all fully funded, but the question becomes if you're a enough money to pay every retiree, what do you do ? Do you continue to seek alpha returns or do you start going to what they call light path and go to just matched cashflow matching to the last dollar paid out? It's interesting dilemma. The Canadian public plans are funded at 120% plus. Corporate plans, on the other hand, if they're underfunded continue to seek these return , but most of the corporate plans have a different dilemma, which in the US have decided to go LDI. So they do like LDI and liability matching with basically migrating to whatever formula of fixed income that they needed, guaranteed cash flows to sort of pay off their, their their members.Damian:
So Ken just threw out this notion called LDI that I want to take a minute to explain: liability driven investment is the idea that if a pension fund can grow their assets so that they're fully funded, they have enough money today to pay all the expected liabilities, their liabilities, the benefits out to their beneficiaries for all of their beneficiaries. Then rather than investing the assets in stocks, they can invest them in very safe government bonds that have a time matching a duration matching so that they get their coupon payments back from these bond investments just in time to make the payments out to the beneficiaries. And then they don't have to take any more risk because it's only invested in government bonds. And pretty much you can kind of put the whole process to bed or on autopilot glide path has Ken called it. It reminds me, I had a client once when I was running a risk management firm, I had a client, a corporate pension plan that came like 98% funded. And they decided to cancel all of the contracts with all of their risk vendors and analyses, because they said, we're going to assume go to LDI. That pension fund today is actually underfunded by about 50%, unfortunately. So there's a lot of devils in the details there about how this stuff works. But I just wanted to explain LDI back to what Ken was talking.Ken Akoundi:
It gets even more complicated when you think of someone like GM. GM essentially is a massive pension plan with a tiny little car manufacturing attached to it. Should the pension plan by the car manufacturer? But at the end of the day, the plans who have a younger population or in better shape than those that have an older population. So New York, Florida, Illinois, California, are all very much older population. And then you have the young population of Utah where still there is a growth of the active members is ahead of the retirees. It become a bit of an inverted pyramid of for supporting the local economies and all that. I tell them about something called the speed of the investment office. And every investment office has one. The speed of investments in the pension fund without technology is as slow as molasses. The hedge funds are the fastest ones , especially the quant traders that are basing the relying on a nanosecond kind of timeframe. And the fastest pension fund is slower than the slowest asset management firm. So they will never catch up because their manager of managers and all these layers of decision-making that comes through. So it's very interesting how I always think that any crisis is a time to learn a lot, but the reality is that the COVID crisis, there was no downside for people. People came out of COVID up 25% and even last, the year before their returns, weren't so bad because they were doing okay, and then they just gave it back. So there was sort of flat-ish the worst case that I knew was negative one negative 0.5% or so negative. The worst, worst case was an, a downward negative 7%, but now all of a sudden they come back 25% is roaring. And , uh,Damian:
Ken , are you saying that their natural slowness to , uh, to react actually benefited them in this case? Cause you know, ha had they moved faster, they might not have come back nearly as much as, as they have in their wouldn't be as good?Ken Akoundi:
That it is correct. The main Japan pension fund public pension plan has I think 1.7 trillion in assets and they clock 25% return. Effectively, their return was larger than CalPERS, total AUM. Right? So when you're that big decisions on the edges are sort of, how are you gonna do, you're gonna pull down your equities from 22% to 20%? That 2% is still means a lot of money that needs to be moved around. So by the time you get a done and the slowness of a service providers, all of this, it's just a one very slow moving ship .Damian:
So Ken who are today's poster children for the best run pension funds and what makes them so much better than the rest?Ken Akoundi:
I'm going to separate United States and Canada from the, from the rest of the world. In Canada, they treat their pension funds like corporations. So in the U S they don't. So if you have example of UC regions with 150 billion of assets, approximately they have about a hundred people servicing that between investments, operations, et cetera. Then in Canada, an entity with a hundred billion, like OMERS has 450 employees thinking about a difference in size. And what that means is that they figured out they pay that whatever fees that US plans pay, and it costs hundreds of millions of dollars paid in fees every year to managers, they can spend a portion of that on internal staff and hire the staff to come in. Not the wall street salaries and the packages, but with somewhere in between wall street and public plan, but what they offer is a better quality of life, a better quality of life after you retire.Damian:
Ken and I then talk about the technology sophistication of some of these plans. And he told me that whenever he speaks with a senior pension fund manager, he always asks one particular question. He asked them how much they think you would take to modernize their technology in terms of dollars. Now, before they answer, he writes down his own estimate and he hides that number until they reveal theirs. And when they share their number, they're always shocked because his is about 10% or 15% of theirs. I didn't say that his is 10% of 50% lower. I said, it's 10% OF their number. So 90% lower. Now this is largely thanks to early technology vendors who charged an arm and a leg and left a lasting impression on these people, that this technology is always expensive. And that led us to talk about why, for example, Google or Amazon hasn't yet come into the industry and taken over. We had a number of reasons around that. One of them basically Ken said, it's not worth it to them. There's just not enough people that they can sell technology stuff to. You know, we're talking about a total of 250,000 people or so working in the pension fund space and arena. But finally, the most interesting thing was Ken offered a really interesting prediction. So he explained that after the global financial crisis and a wave of layoffs from pensions and asset managers, some of those professionals, they started tech firms to service the industry. And one of the things that they do is help lower costs for pension funds. Interestingly, Investment Metrics, the company that I now work for and who sponsors this podcast is one of those tech firms. So Ken saw the wave of today's technology, enabled firms, them coming out of the GFC, and that led him to offer this prediction.Ken Akoundi:
So there's all these companies that are coming out that came out five years after GFC all have great tech. There's a lot of great tech out there. So I'm thinking five years from the COVID peak, we're going to have another wave of tech , new, innovative technologies that are coming down for our industry. So I'm a little bit excited about that.Damian:
Ken, I really want to thank you for joining me , and, and sharing your thoughts with, with listeners and , looking forward to catching up with you in person real soon.Ken Akoundi:
Thanks very much for having me. This was as always Damian, you and I get together, and it's always a lot more fun with a bottle of wine. And we haven't had one of those in a while, but hopefully when things change, you will get back to those days. Thanks for having me.Damian:
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