November 28, 2022

LDI Push to Lower Stock Exposure Reaches Its Destination

The de-risking trend has seen equities cut in half since 2008, to around 30% of assets, and Milliman thinks that’s where it will stay.

Reported by Larry Light

Art by OYOW

Ever since the 2008-09 financial crisis, many corporate plans have been on a quest to diminish their risk exposure via liability-driven investing. This translates to a reduction in their stock holdings. They may have reached what experts say is the sweet spot for stock, about 30% of a portfolio.

One good result of the LDI push is that funded status has rebounded. While de-risking drive has meant that the equity portion of portfolios has shrunk, a strong bull market boosted what remained (until this negative year, of course). Additionally, lower equities exposure meant that, once 2022’s bear market arrived, the plans’ overall market value did not diminish as much as it otherwise might have.

By consulting firm Milliman’s statistics, the 100 largest corporate DB plans ended 2019 at around 90% funded, then fell by almost 10 percentage points during pandemic-stricken 2020’s first half. After that, the funded ratio began to climb back. By early 2022, it reached the fully funded (100%) level, and last month hit 113%.

The shift away from stocks has been radical. In 2005, prior to the financial crisis, the average equity allocation was 60%, with 30% in fixed income and 10% in alternative investments (hedge funds, commodities, private credit, etc.), Milliman data indicate. By 2021, that allocation had undergone a sea change. Equities had fallen to 29%, and fixed income had risen to 51%, with alts claiming 20%

Expect this equity allocation to stay in that vicinity, according to Milliman. “This might be it, in the neighborhood of 30%,” says Zorast Wadia, a principal and consulting actuary at Milliman and the co-author of the study. “You want to keep some equity exposure” to power investment returns, as stocks historically have the mightiest growth potential.

Some pension programs are even more diligent about paring their stock holdings than the statistical averages indicate. Consider pharma company Eli Lilly, whose DB plan as of year-end 2021 was valued at $16.4 billion. Its public equities then were listed at slightly more than $4 billion, or roughly 24% of the entire portfolio. That stock allocation, already relatively low, has been further diminished since. “We lowered our public equity piece this year, before the negative returns started to hit,” says Susan Ridlen, Lilly’s CIO and assistant treasurer.

In recent years, stock prices have soared, but this year has featured a bear market, demonstrating the minus side of share ownership. In 2022, inflation and rising rates pushed down the prices of stocks and bonds (although fixed income has not slid as much).

Making portfolio changes has its challenges. This year, volatility has picked up for both asset classes. Volatility has edged downward a bit lately for stocks and bonds, but the entire year has been a roller-coaster ride, so many institutional investors expect another jump ahead.

For company plans, the result of all this turmoil has been “to keep your powder dry,” said Sean Kurian, Conning’s head of institutional solutions—that is, maintain enough cash to take advantage of opportunities when they arise.

There’s little doubt that liability-driven investing is popular among private employers, with 88% of respondents in Chief Investment Officer’s 2021 Liability-Driven Investment Survey saying the strategy is their preference, compared with just focusing on asset growth in general.