The Public Pension Crisis

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ALM The Future of Asset Management
Ryan ALM, Inc. - The Solutions Company1-888-RyanA
LM www.ryanalm.com

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Client Objective______________

• To fund Liabilities at Lowest Cost
• Individuals Retirement, Education, Weddings
• Institutions Pensions, Lotteries, Ins.,
  Banks, NDT

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Cost ____

• No Cost Assets Fully Fund
  Liabilities
• (No Extra Funds Contributed)
• High Cost Assets Partially Fund
  Liabilities
• (Requires Extra Funds)
• (A/L Deficit)

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Risk/Reward___________

• Intrinsic Value Compared to Risk-Free
  Investment
• Risk-Free Treasury STRIPS Yield Curve
• Investment Horizon STRIPS Maturity
• Compare Relative Risk/Reward
• V8

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Problem Liability Benchmark
Assets need a Benchmark Assets Managed vs. Assets
(Indexes) Asset Only World Liabilities are
MIA ? Liabilities should be the Benchmark!
Requires Custom Liability Index
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Problem Generic Indexes
Represent the market not client liability
schedule Client liability schedule is unique to
each client (snowflakes) Does NOT represent
clients true objective Confucius Given
Wrong Index Get Wrong Risk/Reward
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Assets vs. Liabilities (Annual Returns)
Weight Static Asset Allocation for Each Asset
Class Source Ryan ALM,, Lehman Brothers,
Standard Poors, Morgan Stanley
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Assets vs. Liabilities (Annual Returns)
Weight Static Asset Allocation for Each Asset
Class Source Ryan ALM,, Lehman Brothers,
Standard Poors, Morgan Stanley
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Mr. Clean
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Custom Liability Index (CLI)_____________________
____

• Required to
• Measure the Risk/Reward Behavior of Liabilities
• Build Beta Portfolio (Liability Index Fund)
• Measure Economic Funded Ratio
• Measure True Alpha

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• Custom Liability Index
• _________________________________
• Year Future Value Present Value
• 2018 100,000 65,000
• 2019 100,000 61,000
• 2020 100,000 57,000
• 2021 200,000 53,000
• 2024-2045 4,400,000 1,306,000
• Total 4,900,000 1,542,000
• Age 50, GrandKids 2 (Girl
  1), Retire 65, Mortality 87
• Liabilities Present Value Discounted at
  Treasury STRIPS rates (Yield Curve)
• Retire 200,00 (2024-45), Education 50,000
  (2018-21),Wedding 100,000 (2021)

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• Assets vs. Liability Index
• ________________________________
• Market Value of Assets
  1,000,000
• Present Value of Liabilities 1,542,000
• Deficit 542,000
• Asset / Liability Ratio
  64.9

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Alpha Allocation__________________________

• Asset/Liablity Deficit 35
• A/L Ratio Goal (115) 15
• Time (Liability Duration) 25 years
• Target Alpha (Annual) 2.0 (50/25 yrs)
• ROA 7.50 (Non-bonds)
• YTM 4.50 (Liabilities)
• Alpha Estimate 3.00
• Alpha Allocation 66.6 (66.6 x
  3.00 2.00)

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Tactical vs. Strategic Asset Allocation________
_____________________________Dynamic Objective
Dynamic Asset AllocationFunded Ratio Dictates
Asset AllocationHigh Deficit ? Low
DeficitSurplus ? DeficitSports
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ETFs_____

• 100 Index Funds
• Low Cost Low Risk vs. Index
• High Liquidity Buy/Sell on the Wire
• Well Diversified Array of Asset Classes Styles

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Portable Alpha
Portfolio Alpha
Portfolio Alpha

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Cash Flow_________

• No Generic Index has same Cash Flow as Clients
  Liabilities
• Lehman Aggregate
• (12/31/06)
• 1-3 years 24.58
• 3-5 years 30.46
• 5-7 years 27.09
• 7-10 years 08.91
• 10 years 08.96
• Lehman Aggregate 40 in Securitized
  instruments
• Cash flow behavior tends to move in wrong
  direction
• Rates go up duration gets longer
• Cash flow gets reduced

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Bond Index Weights_________________

• Tradition Market Cap Weighted
• Problem Dont Know Current Amount
  Outstanding
• Treasury Agency Stripped
• Corporates
  Sunk, Put
• Mortgages
  Prepayment

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Bond Index Prices________________

• Tradition Trader Priced ? Matrix Priced ?
• Problem No Bond Exchange !
• Too many bonds in Index
• Skewed to old, poor liquidity issues Can
  NOT buy or duplicate Index

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Alpha Portfolio(s)_______________

• Goal Outgrow Liabilities
• Erase Deficit Create Surplus
• Method Asset Allocation of non-bonds
• Assets Non-bonds
• Negative Correlation to Liabilities

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Portfolio Alpha (Benefits)______________

• As Portable Alpha Transfers Excess Returns above
  Liability Index
• Beta Portfolio grows and grows creating 3 Major
  Benefits
• 1. Reduces Contribution Costs (Fully Funds
  Liabilities)
• 2. Reduces Interest Rate Risks (Hedges
  Liabilities)
• 3. Increases Funded Ratio (Client Objective)

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When to Port Alpha_________________

• Target Alpha Deficit Surplus Goal / Time
  Horizon
• 35 Deficit 15 Surplus / 25 years
• 2 Annual Target Alpha
• Actual Alpha Actual ROA Actual Return of CLI
• Year 2006 (12 - 2) 10 Alpha
• Port to Beta Excess Alpha (as it happens)
• Actual Alpha Target Alpha
• 10 Actual 2 Target 8 Ported

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