Asset Allocation, Asset Managers, Corporate Funds, Defined Benefit, Defined Contribution, Institutional Investors, Pension Funds

IA Strategy: Pentegra Treads Path Less Risky to Fund Liabilities

Pentegra, a White Plains, New York-based provider of retirement plan, fiduciary outsourcing and institutional investment solutions to clients across the U.S., with approximately $14 billion on its platform, is generally risk-averse when it comes to managing defined benefit pension plan assets and seeks the best risk-adjusted returns it can deliver over time. “For us, this means finding the least risky path to funding plan liabilities, where the risk in failing to achieve an arbitrary return objective in any given quarter is less important than minimizing the volatility and variance in funding requirements from year to year,” according to Pentegra Chief Investment Officer Scott Stone.  “We try to match the performance of liabilities here–by getting plan assets to behave like benefit obligations–and in more than 75 years we’ve never missed a benefit payment.”

Scott Stone, chief investment officer, Pentegra

From a portfolio construction standpoint, Pentegra’s primary objective is not to be in the top quartile of fund returns, even though its legacy multiple employer defined benefit pension plan ranked in the top 2% in 2018 in the Investment Metrics/InvestorForce platform, Stone said. “We want to create a long-term, strategic allocation that doesn’t rely on market-timing or large-scale tactical allocation swings. In short, we want alpha over a risk profile that follows the risk profile of the liabilities we must fund,” he explained.

Pentegra takes the following steps when considering investments, according to Stone:

  • An actuarial projection of the cash needs each month/year for distributions, etc.
  • Its board determines the fund’s immunization horizon—how many years of the plan’s obligations it seeks to fund without having to sell assets to cover payouts. 

“When I arrived in 2011, we were 30 years immunized. We are now immunizing 12 years; however, we are scheduled to discuss this again at the next Investment Committee meeting in June. The flat/inverted yield curve may make us extend this again,” Scott said, explaining that “right now, the bond markets say short-term rates are too high relative to the market’s view of long-term rates, and that is why you have an inversion. And when the yield curve inverts, within a year, historically, you have a recession. And in a recession long-term interest rates fall. So, right now we are considering taking some short-term funding volatility off the table and looking to immunize more of the longer end of the curve.”  

  • It creates a fixed-income portfolio with laddered maturities that provides the cash flows necessary to fund the cash liabilities out to the immunization horizon. 

Stone noted that for a fully-funded plan, this can take anywhere from 25% to 40% of the portfolio, which is well within the target allocation of most conventional fixed-income allocations.

  • The overall fixed-income allocation is then derived by taking into account the immunization program.

To the extent immunization takes more assets than desired, the horizon period may be modified, Scott said.

  • The remaining assets are dedicated to a long-term wealth accumulation strategy. 

“This portfolio tends to be the risk-heavy portion of the allocation and is designed to fund the long-term growth in plan liabilities. Active plans need a larger allocation to this strategy, because their liabilities will grow, and the wealth-accumulation aspects must dominate the risk allocation. This strategy will include opportunistic fixed-income investments, but will be heavily allocated to equities, real estate and other higher risk, higher returning asset classes. This part of the strategy is designed to fund the long-duration portion of the liability pool,” he explained.

Founded by the Federal Home Loan Bank System in 1943, Pentegra now manages the retirement plan assets of 10 of 11 existing Federal Home Loan Banks, along with the Office of the Comptroller of the Currency, and approximately 200 member institutions of the Federal Home Loan Bank System. It has fiduciary responsibility for approximately $3.8 billion in the “legacy” multiple employer defined benefit plan, approximately $2 billion in multiple employer 401k plan assets, approximately $4 billion in defined benefit (DB) and defined contribution (DC) plan assets for Pentegra Trust Company and the balance in various record-keeping and other administrative mandates for third-party benefit administration, or other services for which it does not necessarily have fiduciary investment responsibility.

Pentegra’s legacy pension plan remains the largest fund on the platform and was 110% funded as of the most recent plan year-end in 2018.  The Pentegra Retirement Trust, the firm’s next largest defined benefit plan, was over 150% funded.  The overall target asset allocation is approximately 50% equities and 50% fixed income, but has run slightly heavier toward fixed income as Pentegra reduced equity exposure as the market rallied last month. On the equities side, Pentegra is allocated 80% U.S. and 20% non-U.S., with approximately 25% -35% in public equities and the balance in private equity, real estate and other equity structures. On the fixed-income side, the firm is allocated approximately 80% to investment grade holdings and the balance in high yield, structured and direct lending classes.

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