Post-Crisis Pension Portfolios Include More Fixed Income, LDI Strategies

CEM Benchmarking has published a new report analyzing corporate defined benefit (DB) plan investment trends since the financial crisis.

According to the analysis, faced with the dual goals of closing funding shortfalls and reducing pension plan risk, data from close to 100 U.S. corporate pension plan sponsors shows plan sponsors have chosen to retain much of the risk and to let funded status guide their de-risking programs.

While few plan sponsors would want to return to the dark days of late 2008 and early 2009, the analysis suggests that subsequent years have brought their own challenges for pension plans. Equity prices have strongly recovered, bringing some benefit to funded status, but the pension plan sponsors still have faced periods of unprecedented volatility, a prolonged slowdown in global growth, and historically low interest rates. Together, these factors have negated gains in equity asset prices and left many pension plans still far shy of a fully funded status.

“For the 69 U.S. corporate sponsors that participated in the CEM database in 2007 and 2008, the average decline in funded status over 2008 was 30%,” the analysis points out. “A quarter of the plans saw declines in excess of 37%; and fewer than 10% of plans remained fully funded on a U.S. GAAP basis at the end of 2008. Despite the relatively positive returns for many asset classes in recent years, the decline in interest rates has proven to be a large impediment to restoring the funded status of pension plans to pre-crisis levels.”

How have these factors impacted pension plan investment decisions? Strongly, according to CEM benchmarking.

“Since the financial crisis, the predominant investment theme amongst U.S. corporate plan sponsors has been to risk reduction, both on an asset only basis and also more importantly with reference to their liabilities,” the report says. “Consistent with the desire to reduce risk, U.S. corporate plan sponsors have greatly increased their allocations to fixed-income securities and reduced their exposure to public equities and in particular U.S. equities.”

Other data show corporate DB plans have slightly increased allocations to private assets. However, this increase is much smaller than that seen among U.S. public-sector plans over this same time period, CEM Benchmarking reports.

“Another factor that has been cited as holding back de-risking strategies is a reluctance by plan sponsors to de-risk plans while in a deficit, often expressed as not wanting to lock-in deficits,” researchers explain. “One investment concept that has gained prominence as a result, is the de-risking glide path, a formulaic evolution of a plan’s strategic asset allocation that gradually reduces risk as either funded status improves, interest rates increase or both. Thirty percent of U.S. corporate sponsors in CEM’s database stated that they had a formal de-risking glide path in place at the end of 2016.”

Of these plans, according to the report, the vast majority (72%) were based on funded status alone with the remainder based on both funded status and interest rates.

“Admittedly, fixed-income allocation is not a perfect proxy for LDI investing, as it does not capture the duration of the fixed income investments in relation to liabilities,” researchers conclude. “A better metric is hedge ratio, which we calculate as the dollar duration of a sponsor’s fixed-income assets divided by the dollar duration of the liabilities. While CEM did not collect the necessary data to calculate hedge ratios in 2007, the information is available for 2016. The theory behind de-risking glide paths would suggest that the correlation between funded ratio and hedge ratio should be stronger than that between funded ratio and fixed income allocation. The data reveals that there is in fact a stronger correlation between funded status and hedge ratio than for fixed income allocation.”

The full analysis is available for download here.