“Managing the pension is technically a part-time job for me,” says Jeff Berger, vice president finance and treasurer at New Jersey-based Sun Chemical. “I have so many other things to do. Yet, the impact and weighty-ness of the pension situation is so important that sometimes I feel like it’s 100% of my role.”
Herein lies the most common refrain among corporate pension managers—and, also, the most common justification for the outsourcing of pension investment management.
Sun Chemical, like an increasing number of corporations in America and overseas, has already taken steps to partner with external firms for investment management of its defined benefit pension plan. For the firm’s $320 million American plan (which is frozen), Sun Chemical has chosen JP Morgan Asset Management’s Global Multi-Asset group; for its United Kingdom fund of approximately the same size and status, it works with Mercer. The company has been working “for years” to manage both the American and British plans in a similar light.
“Over the past couple of years, a three-pronged strategy has emerged that is focused around being more proactive, as opposed to reactive. Our goal is to get both plans back to fully-funded status, but we found that we had missed opportunities in the past to shore up the funding when market conditions were favorable.”
The three-pronged approach consists of first, a de-risking plan that utilizes pre-arranged triggers through liability-driven investing. As the funded status gradually improves, the portfolio transitions away from “riskier growth assets” into liability matching assets. Second, “because interest rate exposure is really the biggest risk factor inherent in pension portfolios, we wanted to execute some interest-rate hedging,” Berger says. “Third—and we are not as far along with this one—we wanted some downside protection.”
“With JP Morgan, they’re the quarterback of the entire strategy for our American plan,” Berger says, using a decidedly American sports term to describe the outsourcing relationship—and one that is echoed by other plans in a similar situation, including the Morgan Stanley pension fund aiCIO featured in its November 2011 issue. “We also use a consultant – Bellwether Consulting—to help us develop and monitor the strategy, in conjunction with our investment committee. It’s the idea of being proactive, as opposed to reactive, which drove us to this. We are in an underfunded situation. We need to be better positioned to lock-in improvements in funded status when they become available.”
It is unsurprising that the third prong—tail-risk hedging—has caused the most consternation within Sun Chemical. In the trifecta of LDI, interest-rate hedging, and tail-risk hedging, how to execute the latter is by far the most contentious industry-wide.
“I can’t entirely sleep well at night because if there is another capital markets meltdown, we aren’t totally protected against that,” Berger says. “I’m worried about protecting against a complete meltdown, not a 10% drop. It’s very difficult to accomplish, however. The standard approaches—buying puts, collar strategies—are very expensive or problematic. We haven’t really found a solution yet—at least one that is exactly what I’d like it to be.”
Berger says that the firm is looking potentially at a “signal-based approach,” as well as considering switching a portion of the growth segment of the portfolios out of equities into something traditionally less correlated. This could be “alternatives; commodities, real estate, or private equity so that you get a less-risky growth portfolio. You could potentially recapture some of the forgone equity upside with call options, which are more efficiently priced than puts.” Unlike LDI and interest-rate hedging, however, the firm is still in the discussion phase with tail-risk, he says.
“Look,” Berger says, “the lack of resources was the driver here. We’re the sponsor of pension funds, but we’re a manufacturing company. We produce specialty chemicals. There is not a lot of internal expertise or resources for pension management. I am by no means a one-man shop, but there are not many people focused on the investments side of things within the company. So, for us, outsourcing and de-risking was the way to go.”
“Ideally, I would like (managing the pension) to be a small minority
portion of my job,” Berger concludes. “Now that we thought through the
long-term scenarios and chosen our partners—I don’t want to use the word
autopilot, as it requires constant diligence, but it certainly is easier. Will
the pension ever become 10% of my job? I’m not sure. But it won’t be 100%.”