DB Summit: Long-Term Investing

Given the volatile stock market and high interest rates, pension plan sponsors may want to consider custom, liability-driven investment strategies, according to a panel of experts.

Mike Gheen, a vice president and director of retirement plan services at Oswald Financial, told attendees of PLANSPONSOR’s DB Summit last week that investment managers need to create customized portfolios that match pension plan sponsors’ particular liabilities.

While plan sponsors can buy “off-the-shelf products” like a long-term-bond mutual fund or an exchange-traded fund, Gheen said these may not necessarily match specific liabilities.

“You really need to be buying individual securities to maximize that matching potential,” Gheen said. 

Historically, if a plan sponsor did not have a plan that was worth more than $250 million, it was often stuck with off-the-shelf investment options. But Gheen said he has seen this dramatically change over the last few years, and customization now is available for plans all the way down to the $10 million mark.

Gheen recommended that investing in a combination of longer-duration bonds and equities is a viable strategy. If a pension is underfunded, Gheen said it is important to maintain a component of growth assets.

“No two plans are the same, so no two portfolios are going to look the same,” Gheen said.

For plan sponsors looking to terminate their pension plans, Kate Pizzi, partner in and senior consultant for Fiducient Advisors, said sooner may be better than later, because interest rates are high and liabilities are lower. The market is also expecting two or three more rate hikes from the Federal Reserve this year.  

Pizzi added that one of the “biggest nuances” in pension management right now is deciding when it is the right time to offer lump-sum distributions as part of a de-risking strategy on the liability side.

Pizzi said when offering participants a lump sum, the investment strategy needs to focus on what interest rate that payout is based on. Many calendar-year plans base a lump sum payment on a “look-back rate.”.

For instance, any lump sum that is payable in 2023 may be based on rates from late 2022, which could potentially be much higher than those at the time of payout.

In order for plan sponsors to understand and calculate their liabilities, Pizzi recommended that plan sponsors form a strong partnership with their actuaries, especially as interest rates continue to fluctuate.

Pizzi also said rising interest rates are surprisingly “good news” for pension investors because it has caused liabilities to shrink.

“For plans that are underfunded, that liability pie is bigger than the asset pie,” Pizzi said. “Having those dollars shrink more than the hit that the assets took actually has been a win for many plan sponsors.”

Although plan sponsors may worry about the falling stock market, Gheen said they are actually in a better place today than they were one year ago because of the rise in interest rates.

Gheen said many of his clients have seen the rise in interest rates as an opportunity to terminate their pension plans, since their liabilities are lower.

“A number of our clients that have been thinking about terminating the plan feel a sense of urgency,” Gheen said. “They don’t want to take a chance because if rates drop dramatically, they might not be able to terminate the plan.”

On both the asset and liability side, Pizzi said pension plan sponsors should take advantage of opportunities to “de-risk.”

Offering a lump-sum window or engaging in pension risk transfer activity are examples of ways plan sponsors can de-risk on the liability side. Pizzi says these strategies can lead to settlement accounting, which occurs when a significant percentage of liabilities is irrevocably transferred outside of the plan.

Gheen found that a lot of his clients have been shying away from including illiquid investments in their portfolios as they contemplate de-risking and are looking more into interval funds, which are liquid on a quarterly basis. He said his clients find interval funds as an attractive investment because they are looking to terminate their plans soon.

With the current volatile market, using an LDI structure is not a “set-it-and-forget-it,” according to Gheen, and it must be monitored on an ongoing basis, particularly for those sponsors that want to terminate the plan.