Hank Kim NCPERS Jim Link The PFM Group Girard Miller OCERS PENSION OBLIGATION BONDS PANEL Greg Smith COPERA
Hank KimNCPERS
Jim LinkThe PFM Group
Girard MillerOCERS
PENSION OBLIGATION BONDS PANELGreg SmithCOPERA
• Issuers of Pension Obligation Bonds (“POBs”) issue debt in the taxable fixed rate markets and deposit the proceeds into their pension system.
• POBs are a risk-bearing arbitrage strategy between the cost of financing and the return on investment.
Pension Obligation Bond Mechanics
2© 2016 The PFM Group
– Investment rates that are greater than borrowing costs will achieve net savings to the pension obligation.
– POB proceeds should be invested in asset classes that provide the best risk/return trade-off (i.e. Equities).
• POBs replace a ‘soft liability’ with a ‘hard liability’.
Hypothetical Example
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What is the Benefit Bonds Window?
Benefits Bond Window
© 2016 The PFM Group
• The period of time an issuer of benefits bonds can invest bond proceeds in the stock market without witnessing lower stock prices in the subsequent economic recession
– Measured from the bottom of the stock market (which typically corresponds to the trough of an economic business cycle) until thestock market ‘breakeven’ level with the subsequent stock market bottom
– Theoretically, the period in which the risk of subsequent-cycle loss is < 50%– Quantifiable only in hindsight
Colorado POBs
» Risks• Market timing of proceeds
» Mitigated through multiple issuances» Long-term strategy (measurement of success not
until last bond paid off)• Structural issues causing problems
» Variable rate cost of capital» Underfunding future required contributions
» Solutions• Fixed rate debt instruments only• Bond covenants that mandate minimum future funding
» Not a payment default BUT:• Triggers an inherent reporting obligation• Impact on credit rating of the sponsor/issuer
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Long-Term Historical Public Market Returns30-Year Rolling Annualized of 75 Percent Equity and 25 Percent Fixed Income
The portfolio is constructed using quarterly returns ranging from December 1926 through March 2015 with a 75 percent allocation to Equities and a 25 percent allocation to Fixed Income – Data collected and calculated by Aon Hewitt Investment ConsultingThe Equity portion was constructed using the following indices: January 1936 through December 1969 Center for Research in Security Prices US Broad Equity Index, March 1970 through December 1987: MSCI World Index, March 1988 through December 2012: MSCI AC World Index, and January 2013 through March 2015: MSCI AC World IMI Index.The Fixed Income portion was constructed using the following indices: January 1926 through December 1975: Ibbotson Intermediate Term Government bonds, March 1976 through December 1989: Barclays Aggregate Bond Index, March 1990 through March 2015: Barclays Universal Bond Index. Headline CPI—seasonally adjusted— calculation method adjusted over time
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