(June 11, 2013)—The riskiness of a corporation’s core business-measured in credit rating, cash flow volatility etc.-had no bearing on the plan sponsor’s pension fund portfolio, a study by the asset management firm SEI has found.
The paper’s major thesis is that an organization’s ability to manage risk and resulting market volatility will vary greatly firm-to-firm.
The study concluded that for companies with higher degrees of capital liquidity relative to the overall balance sheet and market capitalization, higher allocations to equities would be prudent. However, companies that are capitally constrained will be more severely impacted by volatility and should invest more heavily in fixed income.
According to SEI, companies need to better tailor their risk investment strategies, and they must analyze three specific areas: operational risk, financial risk, and pension risk. Most plan sponsors already utilize sophisticated financial models, but according the study there is a crucial element missing. Capital market assumptions will impact corporate financial performance, and thus the ability of the sponsor to meet the demands of the plan.
Marty Jaugietis, director of LDI solutions for Russell Investments, agreed. While talking with aiCIO for a story about BP’s previously cash flush pension plan, he said, “there are a handful of companies out there—and some of the large energy companies may be examples— where their pension liabilities are small relative to their market capitalization. They also generate so much cash that they don’t need to worry much about the impact of interest-rate or market volatility on their plans. They can potentially afford to fund it even in a bad market scenario.”
BP’s pension portfolio looks a lot different after the Deep Water Horizon oil spill than it did before. The company had previously held higher degrees of capital liquidity relative to market capitalization. After the $38 billion cleanup for damages to the Gulf Coast, BP’s cash flow fell by more than 50%, and in response, CIO Greg Williamson scaled back the pension fund’s equities exposure through liability-driven investing. BP is an example of the reallocation of pension fund investments in response to changes in cash flow and market capitalization. SEI would be proud.