What's the big deal?

The combination of negative cash flows and difficult liquidity conditions can undermine a plan in powerful ways:

Investment managers may be forced to sell assets at inopportune times, in an effort to meet obligations. As the recent crisis has shown, trying to sell even safe assets like Treasuries can be expensive when market liquidity is challenged. Potentially even worse, imagine being forced to sell equities during a market decline like the one we saw in late March.
Percentage returns translate to fewer dollars as the plan's asset levels shrink. As a "decumulating" plan has a shrinking asset base, percentage returns will translate to lower dollar returns. For example, assume your asset base shrinks from $100 million in 2010 to $80 million in 2020. A 5 percent return would have generated $5 million in 2010, but now it produces only $4 million. Negative cash flows can make it progressively harder for a plan to meet investment-return objectives.

Unfortunately, economic theories for managing liquidity and decumulation are scarce. Since the 1940s and '50s, pension plans have spent most of their lives accumulating assets. This was also an era that heralded the emergence and development of revolutionary finance theory. You know the names: Markowitz, Tobin, Fama, French, Sharpe, Treynor, Modigliani, Merton, Miller, Black, Scholes, and many others provided a wealth of innovative thinking for investment management success. However, all their (often Nobel Prize–winning) research shared two common characteristics: long-term horizons and a focus on the "accumulation" stage.

Instant Insights /

We need to talk about the armadillo in the room

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