The Pandemic's Punch on Pension Funds Revisited

Two years ago, Steve McCourt, the Managing Partner and co-CEO of Meketa Investment Group shared his thoughts on the pandemic’s impact on pension funds. However, it was too early in the pandemic, so there were too many unknowns. Steve returns with an update on how the market, trustees, pension funds, and technology have all responded to the disruption.

Some highlights from The Pandemic’s Impact on Pension Funds Revisited:

01:36 – In Our Previous Conversation…
03:38 – The Bull Market Charges Ahead
07:46 – The Pandemic’s Impact on the Trades
13:06 – It’s a Brave New Virtual World

www.meketa.com

Transcript

Narrator  0:02  

This is The World of Multiemployer Benefit Funds with Traci Dority-Shanklin. We believe in demystifying retirement solutions, upholding retiree dignity, and contributing to economic stability through union organizing, pension reform, and legislative activism. In short, we're devoted to busting myths about the labor movement. If you're interested in the enduring power of labor, well, you've landed in the right place. Experts and activists will share their insights, expertise, and stories. Time is short, so let's get started.

Traci Shanklin  0:35  

Today's conversation is with Steve McCourt, who is a managing principal and the co-chief executive officer of Meketa Investment Group. He serves as the lead consultant for several institutional funds with public, Taft-Hartley, endowment, and nonprofit plan sponsors. His consulting work includes investment policy design, strategic and tactical asset allocation modeling, asset-liability modeling, investment education, and investment manager analysis. Steven and I spoke back in May 2020. It was the beginning of the coronavirus pandemic, and we touched on how the pandemic and other economic crises have impacted defined benefit funds. However, when we first had that conversation, it was only the beginning of the lockdown in 2020, so there wasn't very much data available. Steve was generous enough to offer a follow-up conversation for our listeners once some data became available. So, welcome, Steve.

Steve McCourt  1:33  

Yeah, thanks. Well, what an interesting period. 

Traci Shanklin  1:36  

In our previous conversation, you mentioned that many of the funds were in good condition back in the 90s when the first recession of 2000 hit them, then the recovery between 2003 and 2007 wasn't particularly strong. So, when these funds were hit again, by the Great Recession of 2008, it was pretty catastrophic for many of these plans. Then we entered into the global pandemic with an unprecedented shutdown in our economy. And to everyone's surprise, the markets have been seemingly undaunted by the pandemic. How have defined benefit plans fared during and after the coronavirus?

Steve McCourt  2:20  

I'm sure when we talked, I highlighted that the pandemic started at an interesting point in the capital market cycle because we were roughly 10 years a little more than 10 years into a bull market, which for any bull market is very much on the long side, what one would have thought that the pandemic and the economic contraction that it created would have triggered a bear market. If for no other reason, then it happened at the tail end of a bull market shows how much we all know, it turns out that the pandemic triggered another bull market and maybe one of the strongest bull markets in history with the market doubling from the bottom or more in a two-year time period. And that, of course, was a function of fiscal stimulus, monetary stimulus, that continues to this day. And the sort of strange situation we found ourselves in and continue to where throughout the recession, the stimulus was sufficient enough where the average consumer and the average company was on sure financial footing during the recession than they were before the recession. And that's just a very unusual spot to be in. And it has caused prices of all types of assets in which defined benefit plans invest to skyrocket.

Traci Shanklin  3:40  

I'm curious, what is your take on the future of the markets? I mean, are you guys continuing to think that this is going to be a bull market run? Or are you worried about inflation? Or what are some of the concerns that you guys are entertaining at this point?

Steve McCourt  3:57  

I think there's several sort of layers of concern that people should have about the markets, but the most important one and the concern that one would have the most confidence in is just that the valuations of assets, whether they be bonds, stocks, real estate, private equity, whatever asset class you're referring to, are significantly higher now than they were even just three or four years ago, let alone 10/20 years ago. That may mean we're due for a big bear market. But what it certainly means is that forward-looking returns looking out 10 or 20 years are going to be a lot lower. In that sort of framework and context, the strong returns that we've experienced in the last two years, have in essence pulled forward returns that investors would have expected well into the future into the present. So, it feels really good now but plans have to plan for lower expected returns into the distant future. And of course, that's what's driving a lot of plans today to be looking at reducing their assumed rates of return to ensure that they're realistic given where pricing of assets are today. 

Steve McCourt  5:04  

The other layers of concern are, I would say, number one, the combined risk of inflation and policy mistakes by the Federal Reserve to increase interest rates to stem inflation. This high valuation era that we're in right now in assets at its core is all being driven by yields on long-term Treasury bonds being historically low. And they're historically low, in part because the Federal Reserve has been buying billions and billions and billions of treasury bonds and, and is now starting to taper that that purchasing. If inflation is a concern if the Federal Reserve decides not to manage the long end of the Treasury curve, and interest rates are allowed to increase more meaningfully, that is a risk that doesn't just affect bonds, it affects every asset class that derives its value from discounted future cash flows like equities, and in real estate and private equity. So that's certainly a meaningful risk that the capital markets are focusing on today.  

Steve McCourt  6:09  

On the flip side, with all the valuation concerns that one should have and the risk of rising rates and inflation, we continue to be in an economy that broadly speaking is opening and healing. The pandemic was as large a dislocation of any economic activity in the US since the Great Depression. It's going to take several years to get the labor market back to where it was. We're a good way through that process now, but we're still in that process. We still have new employment in the country increasing at very high levels each and every month, which adds, in essence, more demand and stimulus to the economy. The risks are to what happens when those tailwinds pull back. And we all know eventually they do.

Traci Shanklin  6:52  

Before the pandemic, there were 130 funds projected to insolvency with an additional 200 or so plans in jeopardy due to the crisis. It sounds like that number has not increased and in fact, could have gone down. But I'm curious if you know if that number is higher or lower than projected?

Steve McCourt  7:12  

I would have to imagine, Traci, that number has gone down, but I've not seen specifically and obviously, a lot of those plans that are critically and in danger are lined up for funding from Treasury to support benefits through 2051 supposedly, so I think a combination of asset returns being higher than normal the last two years, and the government support for severely underfunded pension plans has to improve that situation.

Traci Shanklin  7:45  

That's good news, I hope, that's correct. For the healthy plans, I guess, how have they fared? Do you have a sense of which type of industries and funds were hit the least or the hardest?

Steve McCourt  7:58  

The impact was incredibly varied. You had some trades where the impact was quite minimal, even at the trough of the recession, work was quite strong. You have others that those trades might be changed forever. I mean, you think about the, you know, hotel, restaurant workers and challenges they've had the last two years. That's a seismic event for them. And it's clear that that part of the economy is not healing as fast as other parts of the economy either. So, there's clearly stress in certain areas of the labor markets. Right now, there's been sort of a host of winners and a host of losers with respect to the hours going into defined benefit plans. But I'd say generally speaking across the organized labor movement, jobs have tracked kind of, at least based on our observation across our clients, the experience of the broader economy, which is, you know, the first couple of months the pandemic, nobody knew what was going to happen to employment to business, but then things have speedily kind of returned back to a level of reasonable normalcy. 

Traci Shanklin  9:08  

Yeah, their resilience has been quite amazing to see, so how have you found that the trustees have responded to the pandemic and the lockdowns? I mean, are the -- is there still an adoption of the more virtual meetings? And do you think that that carries beyond this pandemic?

Steve McCourt  9:29  

We've had a few clients that have been meeting in-person throughout the pandemic. We've had many more that are -- have moved virtual, continue to be virtual, and probably feel like they can get most of their business done fairly effectively, virtually, whether they be Taft Hartley funds or public pension plans, or endowments, foundations. I think the people have realized much of the work that needed to get done. They can do virtually, and I think that's good. I think people have also discovered that there are certain decisions and work that needs to get done at committee levels, that is much harder to do remotely. And I think people will be anxious to get back in person to do some of that. At the end of the day, our industry is a relationship industry and people who want to build and grow relationships with trust funds, are going to find value in finding ways to get together in-person.

Traci Shanklin  10:29  

Yeah, I agree. Have there been any changes in investment approaches due to COVID? 

Steve McCourt  10:37  

On the policy front, the biggest change that we're seeing is driven by not just extraordinarily low-interest rates, but the general consensus that interest rates will be very low for a very long time. And as I mentioned, that drives forward-looking return expectations for every asset class much lower. Many of our clients in the last 12 months has done an asset allocation review, based on new forward-looking expectations, and has made decisions to change asset allocation or not with their eyes wide open based on what forward-looking returns are likely to be. Those dynamics often lead to changes in how groups allocate their capital. While every trust fund is individualistic and does their own thing, there's some themes that are clearly sort of working themselves out. 

Steve McCourt  11:29  

One is clearly given the need for growth assets, equities in portfolios, there's been a significant migration towards more private equity, more private market assets that have the potential to produce higher rates of return than public equities. Maybe without the day-to-day volatility that public equities have. There's been a movement within fixed income towards private credit strategies that likewise can produce higher levels of income, higher yields, and maybe don't have the price volatility that high yield bonds or bank loans have in portfolios. And I think on the flip side, a lot of our clients is one of the really neat thing about being an advisor today in comparison to the late 90s. Most trustees that we work with, understand before we even come to the table that stock prices are crazy. And asset prices generally are just like at the high-end of any sort of reasonable level, and most everybody is aware of risk. So, risk control becomes a much more meaningful topic and investment discussions. In addition to looking at raising allocations to private market assets, many of our clients at the same time are looking at risk mitigating strategies, long-term treasury bonds, hedge fund strategies designed to go up when markets go down to offset some of that volatility of higher equity allocations. Those are the major themes on kind of investment policy changes that I suspect will continue into the next year or two. 

Steve McCourt  13:08  

On the practical standpoint, you know, I think the virtual environment has had and will continue to have sort of a change in how boards govern their investment processes. The historical model of consultants like Meketa, bringing managers to a finalist presentation and trustees to interview them was sort of fading away before the pandemic, but in a virtual world, it's almost gone away entirely because I think most trustees don't find as much value in meeting with new managers remotely. You certainly see a movement towards boards leaning on consultants more for specific recommendations on managers or migrating towards a more outsourced model where the consultant has discretion to hire/fire asset managers, I think that will continue as the kind of virtual world evolves. 

Steve McCourt  14:00  

I think gone are the days where we would meet with 300 managers in our office every year and fly all around the world meeting on-site. I think both managers and consultants have found that they can do better, more rigorous diligence, meeting virtually, meeting more people at the organization's virtually than they can with quick meetings, in-person meetings at people's offices. And so, the process of evaluating managers, evaluating strategies, in some ways, has gotten a lot more robust now, a lot more systematic, a lot more thoughtful in some ways, as it's moved away from kind of a face-to-face dialogue and more to a virtual realm.

Traci Shanklin  14:42  

Have they had to change anything in terms of the way in which they previously said you had to review a manager? I mean, wasn't in-person part of the protocol?

Steve McCourt  14:54  

Some of the reaction is that boards have just chosen not to replace as many managers during the pandemic, because there's always light at the end of the tunnel, and we're gonna be done with this at some point, "Oh, let's wait till then." But obviously two years on, we're kind of reaching the point where boards are saying, "Well, if there's a manager we got to replace, we got to replace them." With some clients that have said, "Meketa, can you just be -- take on discretion to hire/terminate the managers?" We've had some that say, "Well, Meketa, can you just come to us with a recommendation; give us the analysis; give us your -- all your documentation that you go through for your search process; give us two or three options, but we don't need to meet with the managers, we'll rely on your diligence and your advice within that. 

Traci Shanklin  15:37  

And this is a bit of a diversion from my original thoughts in terms of our conversation, but I know I do have a lot of listeners that are on the money management side. And I'm curious if you guys have changed anything in your research, and how a manager would approach Meketa from a research standpoint? Is there any different processes that exist? Are there any other vehicles to getting the attention of the research team?

Steve McCourt  16:06  

I think the challenge, putting myself in the shoes of an asset manager marketing to a consulting firm, the challenge in a remote world is you no longer have that really critical tool of meeting in-person with a research staff at their offices. Without that, I think much like every other business, it's hard to build a relationship. And without a relationship, it's hard to build confidence and trust. And without confidence and trust, it's hard to get endorsement, so that whole kind of chain of events gets delayed because of the lack of ability to meet with people in-person. 

Steve McCourt  16:09  

Pre-pandemic diligence from a consulting firm might look a lot like you know, reviewing an RFP, meeting with a marketing person and a portfolio manager at your office for a couple of hours, doing an on-site meeting to the manager where you meet with a portfolio manager and an analyst. You go back to your office, you write up your notes, you consider your thoughts; you rate the manager and tell the consultants what you think of them. I think post-pandemic now that's become a lot more detailed because virtually you don't need to schedule around people's schedules, you can now have conversations with a dozen different people within asset management firms. You can talk to the Chief Operating Officer, the Chief Financial Officer, the head of research, you know, whoever you want to talk to, to kind of get a rounded view of, of that asset manager. And I would imagine that firms that are more transparent and open to that are going to be more successful in that new world. So, I think even once you're kind of engaged in the research process at a consulting firm that process itself changes a little bit. It's less about pitch books and slides and maybe more about the people that you're engaging with during the diligence process along the way.

Traci Shanklin  17:55  

Interesting. You have been listening to The World of Multiemployer Benefit Funds. And since I'm running a little low on time, I'm going to pause my conversation with Steve McCourt, a managing principal, and co-CEO of Meketa Investment Group. On the next episode, we will finish our conversation about the effects of the coronavirus pandemic on defined benefit funds. Steve will also weigh in on the American Rescue Plan Act and how it impacts some of the funds going forward. 

Traci Shanklin  18:23  

If you've enjoyed today's podcast, please consider supporting us with a voluntary contribution at www.patreon.com/multiemployerfunds. That's www.patreon.com/multiemployerfunds, or you can subscribe to us and leave us a five-star review on your favorite podcast platform. We are available on Apple Podcasts, Spotify, Google Podcast, and many other podcast platforms. And of course, you can always find us on our website at www.multiemployerfunds.com. That's www.multiemployerfunds.com. Here you can find our entire podcast library and join our newsletter. Thanks again for joining the conversation where listeners connect with leading experts throughout the multiemployer world. Be part of the change.

Narrator  19:22  

And that's it for this week's episode of The World of Multiemployer Benefit Funds. We'd love to have your support. You can show your support by sharing episodes, making comments, or heading over to www.patreon.com/multiemployerfunds for other partnership opportunities. Thank you for joining us, and we look forward to the next time. 

Disclaimer  19:44  

Sisu Partners LLC hosts The World of Multiemployer Benefit Funds podcast which contains content and discussions that have been prepared for informational and educational purposes only. No listeners should assume that any discussion on this podcast serves as the receipt of, or substitute for, personalized advice from an investment professional as the information provided on the podcast is not intended to be investment, legal, or tax advice. The company is not an SEC-registered investment advisor and does not solicit clients or raise capital for money managers. Sisu Partners offer securities through XT Capital Partners LLC.