Greg Calnon, managing director of Goldman Sachs Asset Management (GSAM) Global Portfolio Solutions and de facto head of outsourced chief investment officer (OCIO) business, recently passed his 17th year with the firm.
Reflecting on his career during a wide-ranging and frank Q&A with PLANSPONSOR, Calnon noted the OCIO business has been a key focus since about 2010 or 2011.
“It’s been exciting to work on this area over the years,” he explained. “One of the reasons I have enjoyed this job is that it continues to evolve and change as our clients’ needs and expectations change. We are constantly working to solve new challenges and bring new approaches to our clients.”
PLANSPONSOR: We commonly hear from advice and recordkeeping providers in the defined contribution (DC) and defined benefit (DB) plan space that the industry has reached an inflection point. Do you agree with that as an OCIO provider?
Calnon: I do agree with that. Even since 2010 or 2011, the OCIO side of the business has changed quite a bit. Back when I first started working in this space and when it became a key focus for GSAM, the marketplace was still quite new in terms of defining what OCIO even meant. There were traditional providers in the space that were doing investment manager selection and consulting work that was billed with OCIO terminology. Even here at GSAM, we had been providing OCIO work in different capacities since 1995 or thereabout. But the client base was very limited and the services were limited.
Coming out of the financial crisis of 2008, we saw a shift in the type of support that institutional investor clients were seeking. Especially pension plan clients. They had seen their funded statuses fall pretty remarkably, and it caused a lot of people to come to believe that the old way of just blindly allocating a 60/40 portfolio—and assuming an 8% return without accurately mapping assets and investments to liabilities—was not going to cut it moving forward. So, many of our clients started seeking much more strategic and consultative advice for their pension investments.
Over time we saw clients asking for more and more support and services across the board, on risk and liabilities and investments. We decided to make a series of key hires and acquisitions because, up to that point, we had strong capabilities on the asset management side, and decent capabilities on the liability side. To create the modern OCIO experience, we needed to deepen our liability capabilities.
PLANSPONSOR: What did pension plan clients have to say about the traumatic experience of 2008 and how they would do things differently in the future?
Calnon: Many clients were coming to us and saying, “Help us understand the strategic implications of our pension investments and liabilities.” Another common question was, “How does our pension plan fit into our overall corporate ecosystem?” And another: “How does the pension plan fit with my other liabilities and how does the variable nature of the underfunding percentage impact our wider efforts as a business?”
These are complicated questions, as you can imagine, but they are crucial for our clients. Many of our clients have to think about DB plans and DC plans, as well as operating pools, foundations and endowments, etc. Recently, we’ve been asked to do more on the defined contribution side as well, and it’s growing into a bigger emphasis for us. There are a lot of clients out there with both DB and DC plans and they are thinking about how the OCIO approach can make sense.
PLANSPONSOR: Can you point to any other client trends, say in terms of the size of their plans or liabilities?
Calnon: Larger corporations are an interesting client group to talk about right now. There is some personnel turnover going on out there and it is having some impact on large corporations’ ability to stably manage their pension funds wholly in-house.
Another important factor is that there is an expanding understanding among this group of what OCIO can be. How I like to describe it is to say, OCIO can mean what the client wants it to mean. These large plans are coming to realize, in order to get some benefit out of working with a provider like us, they don’t need to just hand over the keys to the whole operation and wash their hands of the ongoing management of the pension. We like to work with engaged clients and we have lots of clients that have a full pension staff and their own CIO working on this stuff, and then we can come in and complement and expand on their capabilities where we are most needed. This is still an evolving question and conversation: What does it really mean to do outsourcing?
Thinking back to 2010 or 2011, our sweet spot for clients was probably $500 million, not much bigger than that. Today the marketplace has clearly evolved and we have multiple clients with multi-billion dollar plans—up to $10 billion.
PLANSPONSOR: Are more clients seeking services tied to both DC and DB plans?
Calnon: Absolutely. When there is both a DC plan and a legacy DB pension in place, more plan sponsors are recognizing they have an opportunity to leverage OCIO services. Up until recently, people were used to talking about the DB and DC plans as different pools of assets with different objectives. And that is still true, but there is also a better understanding that corporations will benefit from taking a more holistic approach to the retirement benefits programs.
Additionally, there is more acceptance of doing OCIO within the DC plan as a standalone service as well, although this is certainly not as common as it is in the DB plan space. It’s something to watch and I would encourage plan sponsors and advisers to follow the latest developments in this space. They may find some exciting opportunities emerging on the DC side.
Speaking more broadly to the issue, I personally believe that the DC plan space in general is ripe for disruption. This business has been done a certain way for a long time, largely based on outdated traditions, and so the signs are clear that change is coming quite quickly. The focus on litigation, the focus on cost, and the focus on outcomes have all made people rethink this area—not to mention the new opportunities to use technology to shake up the status quo.
PLANSPONSOR: Do you see many clients thinking about conducting a pension risk transfer (PRT) transaction?
Calnon: In fact we spend a lot of time these days discussing PRT and group annuitization with our client base, and it still seems to be accelerating. We have participated in a number of these transactions on behalf of our clients, as a strategic partner. Our role is basically to help the whole process be as efficient and thoughtful as possible. We can sit in between the insurer and the plan sponsor client and help facilitate the whole process.
Many pension clients simply want to shrink the size of their pension obligations, and PRT is one clear pathway for them to do it. It’s not an easy job but it is one of the main ways to right-size the DB plan obligation relative to the overall corporate ecosystem. That is central to many of the conversations we have that are focused on strategic issues. As the OCIO provider, we can help with the transitions. We can help figure out which assets will be transferred in kind to the insurance company—it doesn’t just have to be all cash.
And then after you have done the PRT transaction, you now have to reassess your remaining asset allocation. Frankly speaking, after you take away all the retirees within a pension plan, you have reduced the population in your plan that is closest to death, and this has a very material impact on the longevity projections underlying your net liability calculations. These are the kinds of implications we can help the client think through.
PLANSPONSOR: In 2015 and 2016 we heard a lot of dire warnings about growing Pension Benefit Guaranty Corporation (PBGC) premiums, and how this would dramatically impact the PRT marketplace. Do you see this playing out today?
Calnon: Yes, PBGC premiums are a huge driver of activity in this space, I would say. The growing premiums are clearly causing a change in behavior and thinking among plan sponsors in terms of how they assess their unfunded liabilities. It is very dramatic.
I also think it is important to understand how these premium hikes are coming after a long string of other challenges over the last 15 years that have changed the game for DB plans. First there was the market crash of 2001, with the deflating of the dot-com bubble, and then the crash of 2008, with the eruption of the broader financial crisis. Then came the influence of the Pension Protection Act of 2006, which started to change the way corporations thought about DB and DC retirement plans and how they want to allocate their resources for the future. But in my opinion, I would say that the growing PBGC premiums have had the biggest impact on pensions, even over these other factors.
I agree that this conversation has kind of fallen by the wayside as other topics have dominated the conversations in the trade publications. But it is important to bring this up today because it ties directly into tax reform. This is because, one way to reduce variable rate PBGC premiums is to contribute money to the plan and reduce the deficit. If you have a smaller deficit you pay smaller premiums. With the tax reform package coming into play, there has been a big push this year to drive a lot of contributions into these DB plans. Remember—if you contribute you get a tax deduction associated with the tax rate. And as the corporate tax rate is coming down quite dramatically, this in turn changes the calculus and reduces the incentive to make these contributions.
What’s the bottom line? Well, under the old tax regime, it was pretty easy to make a sizable pension plan contribution a net positive from the net present value (NPV) perspective. Moving forward, this will not necessarily be the case, putting even more pressure on pension plan sponsors.