Higher Rates Buoy Retirees and Pensions Alike, but for How Long?

What You Need to Know

Pension expert Russell Kamp says today’s rising rates present excellent opportunities for pension plans and retirement-focused investors.
Even if an investor doesn’t want to take substantial duration risk, they can utilize attractive rates in shorter-term government bonds.
Kamp worries that target date funds assume much too much risk for the average retirement investor.

The U.S. interest rate environment might be creating challenges for the investing community — having just this week helped to prompt the biggest U.S. bank failure since 2008 — but it is also providing “wonderful opportunities” for pension plans and retirement-focused investors.

This is according to Russell Kamp, a managing director and senior fixed income manager at Ryan ALM who has been working on retirement planning and pension funding issues for nearly 40 years, including helping to draft the Butch Lewis Act. As Kamp recently told ThinkAdvisor, it has been several decades since pensions and income-focused individual investors could construct a high-quality fixed income portfolio with a yield of 5% to 6%.

“In the current market environment, this is something that is very accomplishable,” Kamp says. “Bonds are once again beautiful, and we can remove so much uncertainty from a pension plan or a retirement portfolio.”

As Kamp points out, it wasn’t long ago that the U.S. 10-year Treasury note had a yield of less than 0.6%, and it’s hard to understate just how much of a difference the higher rate environment makes for investors who want to fund future income without having to take on excess risk.

“For pension plans or individuals who are striving to achieve a return on assets of 6.75% to 7.0%, we are able to get you most of the way to that objective through a very safe portfolio,” Kamp says.

Kamp encourages both individual and institutional investors (and their financial professionals) to do some serious soul-searching in the days and weeks ahead with respect to the amount of risk they want or need to take. Those who are pursuing traditional levels of anticipated future returns, he says, should strongly consider opportunities to pivot away from risky equities or lower-grade credit securities.

Ultimately, while most market watchers expect interest rates to remain elevated for the foreseeable future, a rapid shift in economic conditions is always possible, Kamp warns. As such, investors who wait to lock in higher rates for longer could end up missing out on what is right now a golden opportunity.

Will Rates Go Even Higher?

Kamp says he is planted firmly in the camp that “both listens to and believes what Federal Reserve Chair Jerome Powell is saying.”

“I am just constantly frustrated to see the way the markets continue to act like they are surprised every time that Jay Powell speaks and confirms his commitment to doing what it takes to tame inflation,” Kamp says. “At this point, given the durability of inflation, a target terminal rate in the realm of 7.0% is a reasonable expectation. I believe that a short-term pivot is highly unlikely.”

The main reason for this outlook is no big mystery, Kamp says.

“We remain in an inflationary environment that isn’t anywhere close to falling back to the 2% target that the Fed has established,” he warns. “With a historically tight labor market and rising wages, it doesn’t appear that inflation will be contained in the near future.”

In this sense, Kamp says, the inflation outlook in early 2023 looks much different than the outlook that was commonly spoken about in early 2022. The sources of inflation have moved from supply chain bottlenecks and manufacturing disruptions towards wages and services, and this type of inflation has historically been much stickier.

According to Kamp, this environment will continue to prove challenging for total-return-seeking fund managers to provide a positive return, even with much higher yields offsetting principal losses.

“While January was a terrific month, as U.S. interest rates fell in anticipation of a Federal Reserve that was going to moderate its rate increases, a realization that no pivot was imminent delivered a miserable February,” Kamp says. “So far, March hasn’t been a lot better.”